HARP The Bank Bailout Continues

by Eric Shierman

Well before Obamacare, the Tea Party was primarily a reaction to the bailout. TARP made people angry, HARP put them in the streets. As local news reporters put microphones in Obama supporters’ faces on Election Day and Inauguration Day, an all too common response was something like this:


Obama supporters were responding to an Obama campaign proposal for reducing mortgage debt that was so expensive, even the 111th Congress under Democratic control would not support it in 2009, fearing it would take money away from stimulus package patronage projects. Before Congress parried it aside, Obama’s proposal provided the trigger for this sudden outburst by CNBC reporter Rick Santelli on a trading floor at the Chicago Mercantile Exchange that is largely credited for kick-starting the Tea Party movement:

In the summer of 2009, the Federal Housing Finance Agency (FHFA) came up with a very limited refinancing plan called the Housing Affordable Refinance Program (HARP). The Obama Administration jumped in front of this independent agency, claiming credit for following through with his campaign promise, because Obama claimed tens of millions of Americans could now refinance their underwater mortgages. Until now, only 894,000 have used the program because it involved four restrictions. One, applicants had to be current on their payments (no late payments in the last 6 months, only one late payment in the last 12 months). Two, banks were subject to a mandatory buy back if any underwriting flaws were discovered. Three, there was a 125% loan-to-value cap. And four, it required a new appraisal.

After months of outside speculation, the FHFA released the details of HARP Phase II on Monday. Obama, always looking for a way to campaign on the taxpayers’ dime, used this as an excuse for a campaign event in Las Vegas whose policy fig leaf saves his well financed campaign a lot of money.

Over the past year, the Obama Administration has been doing all they can to pressure what is supposed to be an independent agency. Its acting head, Edward DeMarco, has heroically stood his ground. By enacting a scaled down version of Obama’s agenda, DeMarco has preempted a fleecing of taxpayers that an eventual political appointee would have pursued. By insisting that homeowners in default remain excluded from the program, it will be more difficult for banks to dump all their toxic assets on to the GSEs (Fannie Mae and Freddie Mac) and thus the US Treasury.

HARP Phase II still provides ample room for mischief by lowering lending standards below even that of the crazy days that led to our present problems. Before, the GSEs could only refinance up to 80% of the home’s market value. In 2009 HARP raised that to 125%. Now they have completely removed the cap. This is crazy! Before, banks were subject to a buy back provision that allowed the GSEs to return fraudulently underwritten Ninja loans. In 2009 HARP retained buy backs, now it has eliminated them – unbelievable.  Before, the GSEs required a new assessment before refinancing. Now this is being waved in favor of the fudgeable methodology of an “automated valuation model.” Without buy backs, should we expect anything other than fuzzy math in those models? Without a loan-to-value cap, who cares? The banks won’t, but taxpayers should!

This is nothing short of a new bail out for banks at the expense of adding more bad debt to the taxpayer owned GSEs. After symbolically complaining that Bank of America has raised their debit card fees to $5 a month, Obama then gives banks a more lucrative revenue stream: a new refinancing boom with lower lending standards. Of course banks are trying to find ways to make payroll after having to pay for costly Dodd-Frank regulatory compliance, but I’m thinking that this is a trade they were more than happy to make. Indeed I’ll bet their lobbyists made this trade in Chris Dodd and Barney Frank’s offices. Where is the outrage?

 

Eric Shierman is a partner at Creative Destruction Investment Partners, writes for the Oregonian under the pen name “Portland Aristotle” on the My Oregon blog, and is the author of the forthcoming book: A Brief History of Political Cultural Change. His articles can be read at: http://connect.oregonlive.com/user/PortlandAristotle/posts.html

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  • Bob Clark

    wow, Eric’s da man.

      Today’s Q3 Gross Domestic Product report shows the economy picking up from a dismal first half (2.5% growth this past summer or Q3).  This only reinforces my opinion we don’t need more stimulus, especially when it comes through additional national debt owed to the likes of China.  What Obama’s jobs bill is really about is tossing new monies to unions who in turn will no doubt spend lavishly on his re-election.  (This is not just an Obama thing, recalling Bush 2 lavished hurricane relief funds on Florida just before the 2004 election. The Tea Party needs to focus on use of the public check book by sitting presidents to effectively buy their re-election.)

    The rebound in the economy (Q3) points out a problem I have with Romney as the GOP’s candidate in November 2012’s general election.  The economy may very well have a good next 12 months, despite the economic waste and discouragement inflicted by the Obama administration during the past three years.  Romney’s campaign seems predicated on taking neutral positions, playing it close to the end, and most importantly, betting on a stale economy.  The one thing going for this is Obama’s energy policy has put the U.S in a box whereby; when the economy picks up, oil prices surge setting an upper limit on economic growth.  But I’d rather not bet (Romney) on such dynamic but rather bet on a GOP candidate who is going to inspire the quest for more economic prosperity.  Right now the only candidate fitting this bill is Herman Caine.

  • valley person

    HARP didn’t put the tea party in the streets Eric.  Fox News and the Koch brothers and talk radio did. How could a program you admit was not even adopted have been the cause? How could a single investor rant have been?  The right wing of the Republican party, otherwise known as the tea party, got organized as a resistance to a loss of power and control. They had government for 6 years and botched 2 wars and the entire economy. They had to shift the blame to something or someone else. Never mind taking responsibility. Double down and repeat your errors. Learn nothing except how to organize street protests. Scare the heck out of people with false claims.

    The financial industry wanted to be de-regulated. They got their wish and blew it. Santelli and his kin could have and should have accepted  responsibility for this.

    • Libs in Corvallis Suck

      Well we see the schmuck of the year posting his LIB drivel again. HARP is just another sorry try by Obama to prop up a dead housing market. Porch monkey supporters like Valley boy will continue to pump up this load of horsesh*t as if it’s the second coming.

      • Founding Fathers

        How sad for your parents that their child grew up to be so rude.

      • Guest

        So no one’s going to call out this racist comment? 

      • Guest

        So no one’s going to call out this racist comment? 

      • Guest

        So no one’s going to call out this racist comment? 

    • The notion that Fox News and the Koch brothers put the Tea Party on the streets seems plausible only to those who don’t want to understand what really happened. The best reporting on the Tea Party comes from New York Times reporter Kate Zernike. She later compiled it into a book titled Boiling Mad Inside Tea Party America. 

      Fox News did not see the Tea Party coming. They had no advanced knowledge of the first one organized by Keli Carender in Seattle which was held three days before Santelli’s rant, but Santelli did. That clip went viral. 

      I do not watch Fox News now or then, but I get clips of it in my Facebook news feed all the time. What I remember is Fox News contributors like Karl Rove and Ann Coulter complaining that the Tea Party was anti-military and anti-family which are conservative code words for libertarian.

      While their initial coverage was negative, Fox News was right. In 2009 the Tea Party was a libertarian revolt against Bush, neocons, and big government conservativism as much as it was about Obama. It utilized the social network infrastructure of the Ron Paul campaign the year before. Fox News liked the Tea Party no more than it liked Ron Paul. 

      Because the Tea Party was the only game in town for so long, Republicans began jumping on its bandwagon. This attracted clowns like Glenn Beck and Sarah Palin and the buffoons that follow them. Polls of self described Tea Party people today are now demonstrably split 50/50 between conservatives and libertarians, but the Tea Party remains a libertarian insurgency within the Republican Party. The 87 freshman House Republicans that were elected last November are very different than the House Republicans who were defeated in November 2006. 

      The only way that I see the Koch brothers involved in the Tea Party, is that they likely give to Freedomworks. Matt Kibbe, who heads Feedomworks is a facebook friend of mine and I am very aware of how hard he works to keep the Tea Party focused on limiting government and away from limiting gay rights. The Koch brothers give generously to libertarian causes but they avoid most of what you might call “right-wing.” 

      If you read Zernkike’s book, you would know that the Tea Party of 2009 did not require much money at all. Compare this to the Occupy movements that has been very expensive from the beginning because it feeds its supporters free food. I spend most of last weekend at Occupy Portland and enjoyed some nice meals at the expense of SEIU’s low wage workers’ monthly dues. Of course defeating centrist Republicans in 2010’s primaries did cost a lot of money. I don’t see Occupy funds being spent as wisely. Free meals are not going to help Brad Avakian defeat Susan Bonomici. 

      The only major economies with deregulated financial industries have been Sweden, Switzerland, Hong Kong, and Singapore. The US has not been one of them. Our financial sector was has been one of the most regulated areas of our economy for a long time. The only major deregulation in recent times was the Clinton Administration’s Financial Services Modernization Act. It allowed the merging of investment banking and commercial banking, a provision that prevented the crisis from being worse, but the Glass Steagall Act itself was a contributing factor to the crisis. Had there never been stand alone investment banks dangerously dependent on an unstable repo market in the first place, the crisis would have been limited to the GSEs, AIG, and small regional banks. 

      • valley person

        Nearly every poll that has surveyed Tea Party “members” (those who claim identification with it) show that it is a conservative movement more than it is a libertarian one.

         Members are older, richer, whiter, angrier, and more religious than the average American. The health care bill, government spending, the economy, and government not representing “the people” are their stated highest concerns. Most of them insist Obama has raised their taxes even though he actually has cut them. Most use Fox as their main news source. 1/3 say Obama was not born in America. 59% like Glen Beck, so I guess a majority of them must be clowns? Over 50% disagree with Roe v. Wade, hardly a libertarian view. They also tend to be anti-immigration and anti Muslim, again, hardly libertarian live and let live positions. They also tend to be pro military and aggressive on foreign policy.

        Republicans did not jump on the Tea Party bandwagon. it was a movement of, by, and for Republicans from the beginning. A certain wing of the party.

        Maybe they didn’t need money at the beginning, and maybe the OWS crowd does need money. That simply reflects that Tea Party affiliates already have money, and the unemployed youth that makes up OWS is fairly broke or paying off student loans.  

        The Koch Brothers financial support for the Tea Party is filtered through Americans for Prosperity, which often organizes nominally Tea Party events. This was covered in the New Yorker.

        The financial industry in the US is regulated on paper, but the Bush Administration and the Fed under Greenspan chose to take a hands off approach all during the housing bubble, thinking and saying on many occasions that it was nothing more than the free market at work and would self correct. And it has, or is still self correcting. The problem is that one result is a drag on the entire economy as housing gets deleveraged. Obama’s attempts to plug some of the housing holes have been too little and too late, not too much. 

        Unregulated stand alone investment banks precipitated the crisis by being leveraged 50 to 1 against very shaky packaged mortgage investments backed up by even shakier insurance scams. You of all people should know this story.

        As an aside, a friend of mine who I consider one of the worlds worst investors told me he was going to start buying and “flipping” houses in early 2006. I knew than and there that the end was nigh. Party over.

        • One thing you will never hear me say, or perhaps read me write is “nearly every poll says” I only care about about scientific polls. That is why I so enjoyed this year’s annual American Political Science Association convention whose papers on the subject gave me that 50/50 split. Reason Magazine, which is obviously not a credible source alone, found similar numbers from their polling of a Virginia Tea Party  convention last year. 

          It is important to remember that all of these studies were made in 2010. The most rigorous look at the Tea Party in the first half of 2009 is Zernike’s book. Being a journalist, she is qualitative not quantitative, but being from the New York Times she is very reliable. 

          If one did not know how the Tea Party began, then one would have a hard time understanding why its opinions on drug legalization, foreign policy, and gay rights continue to be non-representative of the GOP as a whole or why its economic views are more extreme. There is a Ron Paul wing of the Republican Party that is at odds with the Rick Sanatorum wing. Only 38% of Republican primary voters who chose Ron Paul ended up voting for John McCain in the fall of 2008. The way the Paul campaign’s intellectual and social-network infrastucture led to a movement to reject big government conservatism is not a trend to miss if one wants to understand the dynamics of American politics. 

          Anyone who actively follows politics is older, richer, and angrier that the average American. What makes the Tea Party unique is that it has been disproportunatelly more affluent and college educated than the average Republican voter. The Tea Party is remarkable because it has been able to get affluent people out in the streets protesting. Republicans have held protests against abortion, gays, immigrants, and for war, but the people who turn out to these events visibly make less money than the union organizers that populate Democratic events. The Republican Party has disproportunatelly represented lower income rural America. That was the persuasively argued thesis of Thomas Frank’s What’s the Matter with Kansas. When push comes to shove, the GOP does not go to the mat to cut entitlement spending because rural white America IS the welfare state. There has never been a mass American political movement that could put real people on the streets demanding austerity. 

          This is part of a broader Neoliberal establishment that has been supplanting the progressive establishment of the 20th century. This transition was on display for me last night. I went to the AFSME/Occupy Portland rally yesterday at 5. It was sprinkled with he same affluent progressive intellectuals I often see at such events. I did not stay for the march because I then swung over to the Baghdad Theater to watch Steven Pinker’s lecture promoting his new book The Better Angels of our Nature, which is about how commerce, trade, and classical liberal values have dramatically lowered violence, crime and war. I doubt there was a Republican in the room listening to this evolutionary psychologist dis our Judeo-christian heritage, and yet he dissed the romantic Rousseau tradition to equal applause. I have a book coming out in January that argues that the conservatives will bolt from the Republican Party as it establishes a consolidation of this Neoliberal establishment.

          I was at an Americans for Prosperity event recently. They had a real crank for a speaker, followed by two good ones. The good ones seemed to lose the audience with their data and details, but the first one had them jumping up and down with applause for every claim that the UN is behind every regional planning policy. I was convinced AFP’s sole purpose is to keep rural America engaged on economics rather than birther-type rage. Sounds like a worthy cause for David Koch, but it has less influence on the Tea Party as a movement than Freedomworks which I’m sure he supports too as would I if I had that kind of money. Good for them.  

          Anyone who puts “unregulated” and “investment bank” in the same sentence impeaches his own credibility. It’s as if you have never heard of the Securities Act of 1933, the Investment Company Act of 1940, SIPC, or the Series 7. The SEC does not limit its regulations to mere pieces of paper, nor does the NASD. It did not do so in the Bush years; it did not do so in the Clinton years. It is the case that the Fed did not see its job as popping asset bubbles, nor does it today. There was not a single regulation that could have prevented the financial crisis when the GSEs cosigned the full faith and credit of the US taxpayer onto mortgages. 

          Deutchebank, UBS, and Handelsbank were no less leveraged than the five Glass Steagall created American investment banks, and they had worse exposure than Goldman Sachs. These less regulated banks did not face a liquidity crisis because they had more stable sources of short-term credit. 

          • valley person

            I wrote that the finance industry is regulated on paper. In fact, the Bush Administration and  Greenspan were ideologically opposed to enforcing those regulations. Besides, too much money was being made, and the housing bubble helped mask the decline in industry in the oughts by giving people false wealth.

            What stopped Lehman from getting private capital to save itself? It wasn’t the government. And when Lehman went down the whole game was exposed. Banks turned out to have a lot of useless collateral. 

            The polls on tea party members I’m referring to include:

            CBS/NY Times April 2010. Among other findings, a majority support SSI and Medicare without changes. Not libertarian. A majority were deeply attached to Fox News and Glen Beck.

            Quinnipiac University March 2010. Among other things, 80% of tea party members are Republican conservatives. Not much mention of libertarians.

            Gallup, April 2010 found the same. A large majority of Tea party members identify as conservatives and republicans, not as libertarians.

            A U Washington survey found tea party members had strong racist, homophobic, and anti immigrant tendencies.

            All credible, scientific polls. Yes, all in 2010. I don’t know how that changes anything. Suffice it to say that the Jim Demints and Michelle Bachmans and Sarah Palins of the world, all very popular with Tea Party identifiers, are pretty far from Ron Paul.

            I don’t know how one concludes that Republicans at rallies make less than union members at democratic rallies. First off, a fair number of union members are Republican. Second, Republicans as a whole are higher earners than Democrats as a whole. This is quite well established. The myth of most poor people voting Republican is just that. Whats the Matter with Kansas got that argument wrong on data, as a number of critics pointed out.  Andrew Gellman has done a lot of research on this. The confusion stems from the odd situation that richer states are blue, while poorer states are red. But richer people tend to vote Republican while poorer people tend to vote democratic. THough the gap has narowed in recent years.

            Its true poor rural areas in recent years have elected Republicans. I’m not sure poor people in those areas are voting Republican however.

            AFP is about the most misnamed group I have found. AFR would be more like it (Americans For the Rich).

          • When I hear a sweeping statement regarding Greenspan’s or even Bush’s positions on enforcing regulations, it sounds like someone who is avoiding detail, because the closer one looks at the details of that claim the more demonstrably false it is. The Federal Reserve’s regulatory power is both minimal and unlimited. It is minimal in the sense that it has hitherto limited its regulatory power to enforcing the rules of the discount window. Greenspan did not change that, nor did his predecessors or Bernake. The Fed has the statutory potential to become something much more akin to a finance czar, but that would politicize it to the point of threatening its independence. So the Fed limits its role to monetary policy.

            It is hard to take any claim that Bush was some kind of deregulator seriously when he twisted Republican arms to pass Sarbanes Oxley. The history of this law’s origin is spelled out in detail in Ron Suskin’s The Price of Loyalty since it originated in a cabinet meeting chaired by Paul O’Neil. 

            The way in which Bush deserves blame for the root causes of the crisis, is his participation in the empowerment of the GSEs to distort the price of risk to promote home ownership in the first place. The regulatory focus was to scrutinize Wells Fargo’s tight lending standards. Wells Fargo was browbeaten by Congressional committee members of both political parties for being so prude. When it was time for a bailout, Wells Fargo did not need one and tried to opt out. They were forced to take the money so that other banks that were more on board policy makers’ goals would not be stigmatized for accepting assistance. This is not the behavior of a light handed relationship between banks and the state; it is the story of misplaced priorities. 

            Once one understands the cause of the crisis, one then realizes that any tighter regulatory framework would not have any more chance to prevent it than a tougher drug war has a chance of preventing people from smoking pot. 

            Lehman Brothers did not have depositors. Its assets were no worse than UBS, but only in America did we have an insane law that separated investment banking from commercial banking. It also did not have access to the discount window. The financial crisis among investment banks was limited to the instability of the repo market. The near freeze of the repo market in 1998 motivated the Clinton Administration to work towards the repeal of Glass Steagall. The crisis among these legacy, stand alone investment banks ended when they were declared bank holding companies and given access to the discount window. I am not sure Lehman would even have failed had Bear Stearns’ creditors been allowed to get stiffed. 

            The idea of intervening in the smaller firm but letting the larger firm go shows just how incompetent the Bush administration was. This had nothing to do with ideology. If we had no twenty-second amendment, a fourth Clinton term would have let Bear Stearns go, let hedge funds sue AIG when it couldn’t pay, nationalized the GSEs much earlier, dismantled them by now, and vetoed Dodd Frank. I miss Bill. 

            I’m still waiting for that scientific poll of the Tea Party movement in 2009. We don’t have any. All we have are the interviews Kate Zernike did of its first organizers. If you are trying to say that there are traditional Republicans who self describe themselves as Tea Party members, I don’t dispute that. 

            The Times poll was the first scientific poll. I remember when it came out. Only twenty percent of the self identified Tea Party supporters had gone to an event. That was the methodological problem that several working papers in Seattle last month addressed. If I recall correctly, it was Christopher Parker who analogously showed the variance in results if you poll beliefs of self identifying Christians, and compare it to the results of those who answered yes to whether or not they regularly go to church. Then he showed the results for that Times poll when the folks who don’t go to an event are excluded. The median income goes up and their support for Social Security and Medicare drops dramatically. He did the same for the Gallop poll and a few others. 

            The Quinnenipiac U poll got dressed down for its lack of randomness. Perhaps that should have been obvious since it was the only poll to find a majority of Tea Party supporters to be women, only 4% were in the highest income tax bracket, and it found 15% had voted for Obama. I have to wonder if you were rounding up when you said that 80% identified as Republican; it was 74%. This should not be a surprise; most extreme progressives vote Democrat and most extreme libertarians vote Republican depending on how centrist the major party candidate is. 

            Anyone who ever goes to union rallies like I do knows what to look for: you count members. The organizers, or “business reps” are paid to be there. Go to unionjobs.com and look at the salaries they make. I was at AFSME’s rally yesterday. I was really expecting a May Day like turnout. I was surprised it was only enough to fill one block. I was expecting 6k. I did not audit anyone’s tax records, but one can pick up class signals. I am pretty confident that their median income was higher than that AFP group I saw groveling over UN conspiracy theories. 

            Let me give you another easy experiment. Go to a Glenn Beck Oregon 912 event and then go to a Cascade Policy event. The demographic difference becomes too obvious. The list of followers on the facebook page of John Kuzmanich’s Oregon Tea Party is nearly identical to Cascade’s page.

            Regarding income and party identification, the only study I recall that showed a counterfactual result came from Washington University, but I forget the name of the researcher. If I remember correctly it identified an increase in probability that a voter would identify as Republican as his income increased, but the data was skewed by including people who don’t vote. All likely voters skew Republican as well. Since I have been predicting a shift toward Republican affluence, I really keep an eye out for such evidence. 

            I was really exited when Andrew Gellman’s Red State Blue State came out but it was a disappointment. It was less about correlating income and party affiliation than religion and party affiliation. He fails to screen the frequency of church going, making self identified Episcopalians to be a large religious left. I paid good money for  this book when it came out looking for the median income of each party. He does not provide one! He breaks income into thirds showing that the bottom 1/3 of income earners disproportionaly identify with Democrats. That is already known. Control for likely voters and it’s another story. Having said all that, I think as early as the 2012 election the median income of Romney voters will be significantly higher than Obama voters. Perhaps Gellman will have a 2nd edition then and will include that median number when it conforms to his thesis. 

            I had an interesting anecdotal moment regarding affluent Democrats earlier this month when I watched a 1st Congressional District forum for both Republicans and Democrats at the Beth Israel Synagogue. Its moderator, David Sarasohn asked for a show of hands who was a Democrat. The entire room’s hands went up minus Rob Cornilles’ staff and his wife. (Jim Greenfield had neither) This was a very affluent crowd, and that district has Oregon’s highest median income. Only twice that night did a Republican get an applause: when Greenfield made some very hawkish statements regarding Israel which I took to be unique to a synagogue, and when Cornilles pounded the table in support of free trade which I took to be representative of the rise of Neoliberalism amongst our establishment. 

            I think you read my article regarding how the Tea Party can eventually win Nancy Pelosi’s district. There will be a day when those wealthiest zip-codes become Republican and Greg Walden’s district becomes a safe Democratic seat. It will come when a new William Jennings Brian emerges. Bob Casey of Pennsylvania could fit that mold. In 2006, this seemed to be Rahm Emanuel’s vision of the Democratic Party. 

          • valley person

            A lot of smart people have offered very detailed critiques of the whole mess and come to very different conclusions. So when you say “once one understands…” what you really mean is once one understands it the way you do Eric.  I admit I come at this with no expertise in finance, nor do I have a detailed knowledge of financial regulation. So I rely on the analysis of exerts filtered through my tendencies on whom to believe, as well as what is plausible rationally.

            Yes, Bush was one in a long line of Presidents dating back to Truman who pushed measures to increase home ownership. Everything from the GI Bill to the Federal Highway program to tax breaks for mortgage interest   and beyond have helped make the US a nation where home ownership is the norm rather than the exception. the government helped build a stable, middle class society as a result. But Case-Shiller has shown that housing prices tracked income growth almost exactly from 1900 right up until around 2000. At that point housing prices started diverging. This was before Bush did anything. Apparently the table had been set by others, including financial deregulation pushed by Phil Graham and signed by Clinton.

            It was private financial institutions who created zero down, zero initial interest mortgages predicated on continued rise in prices. It was private financial institutions who bundled these junk equities with regular ones in MBS instruments and sold these to other. largely foreign institutional investors. It was private insurance companies, notably AIG who insured all this mess. It was private bond raters who blessed the whole thing with ridiculous high ratings. It was private investors who chose to invest in mortgages. And it was Greenspan who chose to not use the powers of the fed to regulate or oversee it. He himself has admitted he erred by the way. He reflected the belief that the free market, unconstrained by government, would sort out the efficient allocation of capital. And it did. The market decided it had over allocated into housing. The only problem was that the correction took the whole economy down with it, and the financial geniuses that created the mess profited on both ends of the deal while the rest of us get to pay the party bill for years to come.

            Fortune by the way, rated Bear Sterns the best security firn in America a year before its collapse. I think that tells us where the center of gravity was in the investment world no?

            The housing bubble was a private sector phenomenon, and it was just the last in a long line of investment bubbles that end when the last fool rushes in the door. Blaming the government is a reflexive position for a free marketer. Sure, government sets policies that may induce investment in one or another economic sector. Defense comes to mind. But government does not decide where you or other investors choose to put your money. And they don’t create the instruments or manage the investments. If not housing then something else. There have been many, many investment bubbles over the course of the history of capitalism. Capital chases returns balanced against risk. And once a flood starts it creates its own momentum. Large bubbles threaten everyone else, which is why the only entity charged with looking out for the public interest, government, has to regulate. Free market fundamentalists will never accept this.

            As for the rest (party demographics), all good stuff. A poll the other day in the Times said 68% of the richest among us support raising taxes on themselves. What do you make of that, if it is accurate?

          • valley person

            A lot of smart people have offered very detailed critiques of the whole mess and come to very different conclusions. So when you say “once one understands…” what you really mean is once one understands it the way you do Eric.  I admit I come at this with no expertise in finance, nor do I have a detailed knowledge of financial regulation. So I rely on the analysis of exerts filtered through my tendencies on whom to believe, as well as what is plausible rationally.

            Yes, Bush was one in a long line of Presidents dating back to Truman who pushed measures to increase home ownership. Everything from the GI Bill to the Federal Highway program to tax breaks for mortgage interest   and beyond have helped make the US a nation where home ownership is the norm rather than the exception. the government helped build a stable, middle class society as a result. But Case-Shiller has shown that housing prices tracked income growth almost exactly from 1900 right up until around 2000. At that point housing prices started diverging. This was before Bush did anything. Apparently the table had been set by others, including financial deregulation pushed by Phil Graham and signed by Clinton.

            It was private financial institutions who created zero down, zero initial interest mortgages predicated on continued rise in prices. It was private financial institutions who bundled these junk equities with regular ones in MBS instruments and sold these to other. largely foreign institutional investors. It was private insurance companies, notably AIG who insured all this mess. It was private bond raters who blessed the whole thing with ridiculous high ratings. It was private investors who chose to invest in mortgages. And it was Greenspan who chose to not use the powers of the fed to regulate or oversee it. He himself has admitted he erred by the way. He reflected the belief that the free market, unconstrained by government, would sort out the efficient allocation of capital. And it did. The market decided it had over allocated into housing. The only problem was that the correction took the whole economy down with it, and the financial geniuses that created the mess profited on both ends of the deal while the rest of us get to pay the party bill for years to come.

            Fortune by the way, rated Bear Sterns the best security firn in America a year before its collapse. I think that tells us where the center of gravity was in the investment world no?

            The housing bubble was a private sector phenomenon, and it was just the last in a long line of investment bubbles that end when the last fool rushes in the door. Blaming the government is a reflexive position for a free marketer. Sure, government sets policies that may induce investment in one or another economic sector. Defense comes to mind. But government does not decide where you or other investors choose to put your money. And they don’t create the instruments or manage the investments. If not housing then something else. There have been many, many investment bubbles over the course of the history of capitalism. Capital chases returns balanced against risk. And once a flood starts it creates its own momentum. Large bubbles threaten everyone else, which is why the only entity charged with looking out for the public interest, government, has to regulate. Free market fundamentalists will never accept this.

            As for the rest (party demographics), all good stuff. A poll the other day in the Times said 68% of the richest among us support raising taxes on themselves. What do you make of that, if it is accurate?

          • I am not sure finance is any more complex than any other aspect of an economy, but I am sure that anyone who does not take the time to master detail cannot draw sound conclusions about what happened in 2008 nor make persuasive policy prescriptions for the future. 

            There is a lot of literature available on the financial panic of 2008, a great deal of it lacks detail or credibility. There are four books that I would consider canonical, providing lucid analysis from facts gathered from primary sources and data and written for a general audience by established reporters: 

            1) The New York Times’ Andrew Ross Sorkin’s Too Big to Fail is a Bob Woodward like account of the panic among investment banks showing how Glass Steagal; made them vulnerable to panic in a way their global counterparts were not. He also shows how Graham Leach Bliley (has Graham’s name on it but there would be no Financial Services Modernization Act without Robert Rubin just as there would be no Sarbanes Oxley without Paul O’Neil) allowed mergers and the discount window to solve the problem long before TARP. Sorkin shows how TARP was needed to protect Citigroup and small regional banks, all of which should have been allowed to fail. And Sorkin hammers home the mistake of bailing out Bear Stearns’ creditors but not Lehman Brothers’. (this particular principle is salient right now as the ECB thinks Greece can be supported, but recognizes they can never raise enough capital to finance Spain, France, and Italy)

            2) The Financial Times’ Gillian Tett’s Fools Gold provides a very lucid narrative so that anyone should be able to understand why AAA rated CDOs became illiquid, but none have defaulted. There are a lot of smart people out there who are not aware of that fact. Walter Bagehot’s distinctions between illiquid and insolvent is very key here. That is the utility of the discount window, to deal with solvent institutions when they become illiquid during a panic. Probably the greatest misunderstanding out there was that Bear Stearns and Lehman Brothers were insolvent. 

            3) Joe Nocera’s All the Devils are Here and 4) Gretchen Morgensen’s Reckless Endangerment, both work for the New York Times and both pound the table hard on the point that no matter how draconian your regulatory policies, if the government allows GSEs to cosign the full faith and credit of the US taxpayer on to any form of debt, it will so distort market behavior by mispricing risk. Indeed it was Morgensen who gave me that analogy about the drug war. To say this is the result of natural market behavior is to say that Solyndra represents natural market behavior. 

            You are confusing crony capitalism with my free market position. The Clinton Administration was more free market orientated than the Bush Administration. I spelled out how they would have handled the crisis. This returns us to the substance of my article above. Here is Obama engaging in more crony capitalism. He is lowering lending standards to subsidize risk. That’s “more of the same” not “change we can believe in.” Where is the outrage?

            I love the blogoshpere, I really do, but its brevity cannot replace the detail that books from credible sources provide. “Once one understands the cause” does not mean they agree with me. It means they take the time to understand, to master detail. Had I not taken that time to read these and several others of lesser quality, I would have blamed this all on Greenspan too, for his counter-cyclical monetary policy. Heck, I run into really smart people all the time who have never cracked open an introductory economics textbook, and yet provide all manner of complex explanations for how recessions are caused and what gets us out of them. These four books should not be experts filtered out “by your tendencies.”

            Home ownership harms the middle class. It is as if the government subsidized gambling and alcoholism. People who own their homes pay more in rent that people who rent an apartment. If it were not subsidized, the market for quality middle class rental housing like the Swedish and German middle class enjoy would not be crowded out. Besides making us path dependent on more costly means of living, excessive home ownership also creates labor market inefficiencies by adding friction to relocation.

            That inflection point on the Case-Shiller index you identify has a rather obvious causal explanandum. Look at what interest rates were doing. The north star of finance is the risk free rate. Manipulate the risk free rate and you will create a systemic mispricing of risk. Risk averse money will buy assets with too much risk.

            Fortune’s rating of Bear Stearns was simply a ranking of its earnings. Anyone familiar with the Capital Asset Pricing Model would know this made Bear more risky an asset not less. When people make bad investment choices they should lose their shirts. This should be limited to mere microeconomic phenomena. The systemic mispricing of risk is not something that sound monetary policies in Sweden, Switzerland, Singapore, and Hong Kong have to deal with. All four of those countries have freer economies than we, even Sweden, as we discussed before, but they don’t face endogenous shocks from burst asset class bubbles. One does not have to be a “market fundamentalist” to observe the obvious. One would have to be somewhat versed in the fundamentals of economics I suppose. 

            It requires a tremendous amount of faith to believe that government power can be directed for the public good. When elites can use the coercive power of the state to compete rather than market forces, its execution serves the public good less than its voluntary transaction alternative. You identify problems caused by crony capitalism, fair enough, but it does not then follow support policies that will lead to more crony capitalism.

            It is no big deal from the perspective of the rich to pay more in taxes. They are at a point of satiation where they are giving the money away anyways. What you catch by asking more probing questions, like Charlie Rose does, is what they think of government spending. Warren Buffet is not always on message in this regard. When asked why he does not just write a larger check to the government himself, he does not respond with some rule of law answer, or even a concern that his own money will not be enough. Buffet points out that he has signed off all his wealth to the Bill and Melinda Gates Foundation which he sees as having a higher impact dollar per dollar on the needy than government spending. It is not that the rich need more money. Society needs the higher return on investment both for their financing of venture capital and more effective charity. Another common caveat I hear Charlie Rose elicit, is the desire to pay more in taxes if it would be guaranteed to pay down the debt. 

            Twelve years ago, I liked Bill Clinton’s rhetorical efforts to direct all surplus money to “save social security.” This was a great way of describing paying down the debt. The largest owner of Treasuries is the Social Security Administration. They don’t float in the open market, and often don’t get counted in debt calculations. When they begin to get cashed in around 2017, it will look identical to a regular Treasury auction. That seemed more sensible than the Bush tax cuts to me. I am of course making a political calculation that surpluses would continue to be directed in that sound way. There is a lot of evidence that my political calculation would be wrong. 

            I actually agree with your claim that the richest 1% are becoming more Republican; they just aren’t there yet. What “Republican” means is changing too. That is why I am focused on the factional dynamics within the two centrist parties, and why I spent the weekend “in the field” at Occupy Portland. Something big Gellman missed was how the religious right has been moving to the left on economics. Times they are a changing. 

          • I am not sure finance is any more complex than any other aspect of an economy, but I am sure that anyone who does not take the time to master detail cannot draw sound conclusions about what happened in 2008 nor make persuasive policy prescriptions for the future. 

            There is a lot of literature available on the financial panic of 2008, a great deal of it lacks detail or credibility. There are four books that I would consider canonical, providing lucid analysis from facts gathered from primary sources and data and written for a general audience by established reporters: 

            1) The New York Times’ Andrew Ross Sorkin’s Too Big to Fail is a Bob Woodward like account of the panic among investment banks showing how Glass Steagal; made them vulnerable to panic in a way their global counterparts were not. He also shows how Graham Leach Bliley (has Graham’s name on it but there would be no Financial Services Modernization Act without Robert Rubin just as there would be no Sarbanes Oxley without Paul O’Neil) allowed mergers and the discount window to solve the problem long before TARP. Sorkin shows how TARP was needed to protect Citigroup and small regional banks, all of which should have been allowed to fail. And Sorkin hammers home the mistake of bailing out Bear Stearns’ creditors but not Lehman Brothers’. (this particular principle is salient right now as the ECB thinks Greece can be supported, but recognizes they can never raise enough capital to finance Spain, France, and Italy)

            2) The Financial Times’ Gillian Tett’s Fools Gold provides a very lucid narrative so that anyone should be able to understand why AAA rated CDOs became illiquid, but none have defaulted. There are a lot of smart people out there who are not aware of that fact. Walter Bagehot’s distinctions between illiquid and insolvent is very key here. That is the utility of the discount window, to deal with solvent institutions when they become illiquid during a panic. Probably the greatest misunderstanding out there was that Bear Stearns and Lehman Brothers were insolvent. 

            3) Joe Nocera’s All the Devils are Here and 4) Gretchen Morgensen’s Reckless Endangerment, both work for the New York Times and both pound the table hard on the point that no matter how draconian your regulatory policies, if the government allows GSEs to cosign the full faith and credit of the US taxpayer on to any form of debt, it will so distort market behavior by mispricing risk. Indeed it was Morgensen who gave me that analogy about the drug war. To say this is the result of natural market behavior is to say that Solyndra represents natural market behavior. 

            You are confusing crony capitalism with my free market position. The Clinton Administration was more free market orientated than the Bush Administration. I spelled out how they would have handled the crisis. This returns us to the substance of my article above. Here is Obama engaging in more crony capitalism. He is lowering lending standards to subsidize risk. That’s “more of the same” not “change we can believe in.” Where is the outrage?

            I love the blogoshpere, I really do, but its brevity cannot replace the detail that books from credible sources provide. “Once one understands the cause” does not mean they agree with me. It means they take the time to understand, to master detail. Had I not taken that time to read these and several others of lesser quality, I would have blamed this all on Greenspan too, for his counter-cyclical monetary policy. Heck, I run into really smart people all the time who have never cracked open an introductory economics textbook, and yet provide all manner of complex explanations for how recessions are caused and what gets us out of them. These four books should not be experts filtered out “by your tendencies.”

            Home ownership harms the middle class. It is as if the government subsidized gambling and alcoholism. People who own their homes pay more in rent that people who rent an apartment. If it were not subsidized, the market for quality middle class rental housing like the Swedish and German middle class enjoy would not be crowded out. Besides making us path dependent on more costly means of living, excessive home ownership also creates labor market inefficiencies by adding friction to relocation.

            That inflection point on the Case-Shiller index you identify has a rather obvious causal explanandum. Look at what interest rates were doing. The north star of finance is the risk free rate. Manipulate the risk free rate and you will create a systemic mispricing of risk. Risk averse money will buy assets with too much risk.

            Fortune’s rating of Bear Stearns was simply a ranking of its earnings. Anyone familiar with the Capital Asset Pricing Model would know this made Bear more risky an asset not less. When people make bad investment choices they should lose their shirts. This should be limited to mere microeconomic phenomena. The systemic mispricing of risk is not something that sound monetary policies in Sweden, Switzerland, Singapore, and Hong Kong have to deal with. All four of those countries have freer economies than we, even Sweden, as we discussed before, but they don’t face endogenous shocks from burst asset class bubbles. One does not have to be a “market fundamentalist” to observe the obvious. One would have to be somewhat versed in the fundamentals of economics I suppose. 

            It requires a tremendous amount of faith to believe that government power can be directed for the public good. When elites can use the coercive power of the state to compete rather than market forces, its execution serves the public good less than its voluntary transaction alternative. You identify problems caused by crony capitalism, fair enough, but it does not then follow support policies that will lead to more crony capitalism.

            It is no big deal from the perspective of the rich to pay more in taxes. They are at a point of satiation where they are giving the money away anyways. What you catch by asking more probing questions, like Charlie Rose does, is what they think of government spending. Warren Buffet is not always on message in this regard. When asked why he does not just write a larger check to the government himself, he does not respond with some rule of law answer, or even a concern that his own money will not be enough. Buffet points out that he has signed off all his wealth to the Bill and Melinda Gates Foundation which he sees as having a higher impact dollar per dollar on the needy than government spending. It is not that the rich need more money. Society needs the higher return on investment both for their financing of venture capital and more effective charity. Another common caveat I hear Charlie Rose elicit, is the desire to pay more in taxes if it would be guaranteed to pay down the debt. 

            Twelve years ago, I liked Bill Clinton’s rhetorical efforts to direct all surplus money to “save social security.” This was a great way of describing paying down the debt. The largest owner of Treasuries is the Social Security Administration. They don’t float in the open market, and often don’t get counted in debt calculations. When they begin to get cashed in around 2017, it will look identical to a regular Treasury auction. That seemed more sensible than the Bush tax cuts to me. I am of course making a political calculation that surpluses would continue to be directed in that sound way. There is a lot of evidence that my political calculation would be wrong. 

            I actually agree with your claim that the richest 1% are becoming more Republican; they just aren’t there yet. What “Republican” means is changing too. That is why I am focused on the factional dynamics within the two centrist parties, and why I spent the weekend “in the field” at Occupy Portland. Something big Gellman missed was how the religious right has been moving to the left on economics. Times they are a changing. 

          • valley person

            I saw the move version of Sorkin’s book. Since Glass Steagall was repealled in 1999, I don’t know how that caused panic in 2007. Yes, letting Lehman go was stupid. And based on Sorkin’s movie, the stupidity was rooted in Paulson’s free market ideology. His character stated as much anyway.

            I have seen an interview with Bethany Mclean talking about her book and its findings. She said very clearly that the financial instruments Wall street created were the primary cause of the crisis. Once banks were able to off load subprime mortgages, the game changed and mortgages went from being low risk investments to high risk ones. Lenders stopped caring about the ability of the borrower to be able to pay for years on end. They even talked borrowers into higher risk ARMs who were well qualified for low risk 30 year conventionals because they (Washington Mutual in particular) could package the ARMs and re-sell them easier. Housing mortgages became a game of flipping to the next fool in the line. And record keeping was so sloppy that to this day no one really knows who owns what piece of which mortgage, evidenced by the foreclosure fiasco.

            Gillian Tett seems to confirm the role the financial instruments played in the crisis. (Interviewed on NPR). The risk of mortgages were transferred from individual institutions to the economy as a whole through the sale of bundled, largely crappy bits of subprime, the buyer of the crap having no idea who the mortgage holders were. All was fine while prices went up. Once the last fool rushed in, the game was up. Tett also points out that banks have a “utility” function in society. They aren’t like the local dry cleaners. That is why regulation and oversight is crucial. She talks about the “revolution” in finance that caught everyone off guard.

            Government policy to encourage home ownership was an enabler, but those policies were long standing. What really changed was the financial industry and its relationship to mortgages. It took private financial markets to make a mutton pie out of what had been a boring but stable business.  Government may have encouraged this, but did not do the deed. This was a private sector fiasco.

            “It requires a tremendous amount of faith to believe that government power can be directed for the public good.”

            No. It just takes some objective observation. Government power was essential to first acquiring and then settling the entire west, helped get the western railroads built, helped irrigate the land to allow farming, built dams to provide low cost hydro we still enjoy, set aside national forests and parks to protect our watersheds, wildlife, and have places to recreate, built clean water systems, educates our kids, and keeps the air reasonably clean among other things. To me, it takes a tremendous amount of faith to believe that unregulated, free market capitalism will result in more good than harm. And I say that as a private business consultant.

            Fact is Eric, we have a trillion dollar deficit. We aren’t going to come near to closing that unless the rich, and probably the rest of us, pay more in taxes. The last year, and current congressional super committee, should have shown everyone by now that we are not going to cut government spending enough. Republicans are fighting defense cuts, seniors will unelect anyone who cuts their benefits, and there isn’t enough left in other areas to make the difference. Ron Paul is not going to be president.

            I did not say the richest are becoming more Republican. They seem to be going the other way.  They went for Obama in 08, and unless the R’s nominate Romney, who is clearly one of them, they will probably stick with Obama.

          • Watching movies and listening to interviews cannot substitute for delving into detail, because all one has to do is surf around for a favorite scene or a favorite conclusion that responds to a particularly leading question. That is why so much dialogue flees from detail, embracing sweepingly vague causal claims. Urban legends emerge, and bad policies get enacted that cause more harm than having no policies at all. Investment banking had nothing to do with the bank panic in 1932, but Glass Steagall separated it from commercial banking anyway. Let’s focus on detail.

            The way Glass Steagall led to the investment banking side of the crisis in 2008, which was very peripheral, but got most of the attention, should be very obvious. Investment banking which is far less risky than commercial banking was made dependent on the repo market and excluded from the discount window. No other economy in the world arbitrarily set itself up for failure like that. Its like “hey let’s take one of the least risky aspects of finance and make it as risky as possible!” 

            UBS, Deutchebank, and Handelsbank all had exposure to illiquid CDOs, indeed they had it worse and it remains worse than our Glass Steagall legacy American investment banks. Like Bear Stearns in March 2008, the rest of the world’s investment banks were and remain solvent, but unlike Bear Stearns, they were not legally excluded from a stable source of credit. We got a taste of the inevitable in 1998, the Clinton Administration had the leadership to do the right thing and push for the partial repeal of the worst banking law in US history. Had they not done so, the crisis would have been far worse. Had there never been a Glass Steagall Act, there would not have been an investment banking aspect of the crisis. The moment Morgan Stanley and Goldman Sachs were given access to the discount window, the investment banking side of the crisis was over – long before TARP. That is the most salient fact from Andrew Ross Sorkin’s book. If it did not make it into the screen play don’t blame the producers. 

            The problem was not that Lehman Brothers was allowed to fail. The problem was that the creditors of Bear Stearns were protected and not the creditors of Lehman Brothers which was twice Bear’s size. If the creditors of Bear Stearns would have been burned, Lehman Brothers would not have been able to float commercial paper to supplement their drying repo market, preventing Dick Fuld from playing hard to get with Robert Diamond.  You cannot jerk the money market around like that, without making things very worse very quick. 

            You keep ignoring the gorilla in the room, the GSEs. You listen to interviews where people refer to Wall Street, forgetting that is merely a term for the financial sector. The GSEs are Wall Street. So when you hear someone say “the financial instruments Wall Street created caused the financial crisis”, for you to claim that the GSEs cosigning the full faith and credit of the US taxpayer was not the material cause,  you have to make the absurd assumption that had it not been US policy to remove the risk from these assets, investors would have behaved the same way. 

            A subprime AAA CDO is only more risky than a prime AAA CDO for the GSEs not the “last fool it has been flipped” to. The fools here were the policy makers who were trying to distort the price of risk. The guy holding the CDO loses nothing more than temporary liquidity. 

            Something that people who shrug off details do not seem to understand is that AAA CDOs have not been defaulting. There have been high yield equity tranches that have defaulted, but surprisingly much less than one would expect, indeed they default at a lower rate than high yield corporate paper. I am sure a mezzanine tranch has defaulted somewhere even though it is so rare it never makes the news. When you say these are crap you seem to be confusing liquidity with solvency. 

            The reason the owners of CDOs are not winning big law suits against the originators of these financial products is that the products have performed as advertised. If you have ever seen a prospectus for a CDO you would know there are warnings all over the place that this is an OTC product and the dealer is not a market maker. 

            But if you did are not even aware that CDOs all have prospectuses then I can only imagine what you think when you hear Gillian Tett talking about investors not knowing what they own. This is the source of the liquidity problem in the mortgage market. If you want to sell Johnson and Johnson bonds, every bond is the same. They are a commodity. To have a liquid market you have to have an undifferentiated quality to each unit traded. Mortgages are unique to every home and homeowner. CDOs try to turn mortgages into a commodity. Every CDO has a detailed prospectus. The underwriting info and location are in every prospectus, as well as tranch seniority, but it is a time consuming process to go through and read it all, putting friction on the ability to quickly execute trades during a financial panic. When liquidity dries up, prices drop. This is very different from default. Financial institutions like UBS, Deutchebank, and Handelsbank with stable daily cash flow can deal with illiquid assets. 

            If you think this is bad compare it to its alternative. Small regional commercial banks and credit unions continue to fail. Unlike Wells Fargo, Keycorp, and US Bancorp, they will never pay back their TARP funds. Hundreds of these banks have failed because they had limited access to securitization. They could not manage their risk. Their assets were even less liquid. Securitization substantially reduced risk in the US financial sector. But the mortgage market would have been much smaller and its buyers would have shown greater due diligence had the price of risk not been distorted by the GSEs in the first place. 

            Think of a forest fire. The GSEs are like the forestry practices that create a more combustible forest, artificially low interest are like the global warming that creates the drought. When the price of risk is distorted, stopping the creation of an asset class bubble with tighter regulations is like trying to prevent forest fires with tighter anti-smoking regulations. You seem to be fleeing from the obvious in a quest to cling to some bumper sticker notion of what banking regulation can do. This clearly requires an unmistakable avoidance of detail.  

            Government power is so often abused by elites to carve anti-competitive moats against competition and rent seek against the public good that a cumbia disposition towards it leads to great harm. Glass Steagall is a good example. You list a few examples where government is obviously needed. Certainly we needed the government to conquer the Indians in acquiring the West, but not to build the railroads. That was a disaster; are you kidding?

            The Union Pacific, Central Pacific, and Northern Pacific railroads were the Milwaukee Light Rail like boondoggles of their day. They all went bankrupt stiffing the US Treasury’s loan guarantees. They also no doubt crowded out private ventures that would have cost the US treasury nothing. In case you do doubt that, the best built, and only original transcontinental railroad not to go bankrupt was the Great Northern Railroad, which ran from St. Paul to Seattle. James Hill was not politically connected so he built the Great Northern without subsidies. The lesson should be clear, that which is privately owned is properly cared for, but when the government distorts the price of risk it distorts the behavior of entrepreneurs. This was true of both railroad engineers who failed to scrutinize their costs and professional investors who failed to read prospectuses. 

            Most infrastructure probably needs to be financed by government. In this case the principle of subsidiarity should hold. Fortunately, article I section 8 of the constitution limits the federal government’s scope. When the people of New York wanted the federal government to finance the Erie Canal, James Madison who drafted article I’s language was President. He vetoed it claiming it was unconstitutional. The Erie Canal was a worthy project, and the State of New York financed it instead. 

            A cumbia disposition towards federal transportation spending has led to incredible waste once we forgot about enumerated powers. Tri-met has to limit bus frequency in east Portland, but they will go forward with spending $207 million a mile to connect Milwaukee with light rail which includes a huge, expensive, and grotesque statue that costs more than the price of  increasing the frequency of buses. When money is taxed in Oregon, sent to Washington DC in a leaky bucket only to be returned to Oregon for a stove-piped project, it is not free money, but Tri-Met behaves like it is. The opportunity costs are enormous. When it comes to opportunity costs, what you don’t know can hurt you. Check this out:
            https://www.oregonlive.com/portland/index.ssf/2011/10/trimet_facing_another_budget_g.html

            In addition to avoiding details, you shelter your arguments in a great deal of equivocation. When crony capitalism leads to failure its all the private sector. When government intervention leads to massive waste of society’s resources as in the great railroad bust, its the good old days of settling the west.

            It is a straw-man argument to say that a free market means the government will not protect people from the negative externalities of others, but a free market does require we restrain the government from causing negative externalities from its own policies. Distorting the price of risk in housing finance has not led to the losses that our railroad failures delivered US, but they might have had we never repealed Glass Steagall.

            Romney or Obama, with an evenly split house and a 51 seat Republican majority in the Senate: 2013 the year of austerity! Obama could have rammed Bowles Simpson through the present Congress in January, instead he offered a budget than neither cut spending OR RAISED TAXES, big missed opportunity. Hopefully the bond market will let us wait till 2013. 
             
            Regarding class correlation of party identification, I could have sworn you were trying to challenge a claim of mine that the Democrats have represented the political values of the rich, but that’s OK. Even though I wrote a book about this, I much prefer talking about crony capitalism.

          • valley person

            ” When you say these are crap you seem to be confusing liquidity with solvency.”

            No. I’m saying that because according to the people you yourself cite, private lenders talked otherwise solvent individuals into signing up for time bomb mortgages so these could be sliced and diced, packaged with decent mortgages, and re-sold under phony AAA ratings to investors with far less detail on what was contained within. Mortgages had always been low liquidity investments but became otherwise through the bundling process. The bundles were highly liquid until they weren’t, which came as a shock.   And they no longer were because they were toxic and clearly declining rapidly in value. No one would touch them. And since the banks, investment and otherwise held so many of them, they (many of them) were on the verge of collapsing and the credit of the nation was in seizure.

            No, I lack the details. But that is the story line I got from your own cited sources. And I did not cherry pick. I listened to hour long interviews and saw a 2 hour film version of a book. The authors/film writers had every chance to offer your story line. But they did not. Or if they did it was buried deep enough that I did not detect it.

            According to Gillian Tett, again one of your own sources, the reason few are being prosecuted or sued successfully is that nearly all of this was perfectly legal. you should be making your detailed arguments to the authors you cited, who disagree with you, not waste them on the likes of me.

            The financial instruments were created by the investment banks, aka “wall street.” They found ways to securitize disparate mortgages and turn these into revenue. Yes, i use shorthand. Guilty as charged.

            “When liquidity dries up, prices drop. ”

            Yes, I suppose. But in this case the liquidity was based on rising prices, and when they peaked and started declining liquidity dried up. Or are we just arguing chicken and eggs here? The point is our financial system became over invested in a single commodoty. As long as money was being made all was great. As soon as the last fool came in the door the game was up. A classic bubble, which as I said there have been hundreds across the centuries of capitalism.

            Blaming the government for the logical consequences of private greed is disingenuous. The government’s failure was its decision to de-regulate and then look the other way. And it did so because of free market ideology of the government preceding and during the bubble.

            You say interest rates were “artificially low.” I’ve heard others make that claim. But what is “artificially low”? We had low inflation, other than in housing, from the late 90s through the bubble. THat would indicate production at or below capacity. Why should interest rates have been any higher in this period?

            “The Union Pacific, Central Pacific, and Northern Pacific railroads were the Milwaukee Light Rail like boondoggles of their day.”

            The former were private enterprises using government incentives to build private facilities the government wanted to help settle and knit together the west. The latter is an entirely public facility. I don’t see how you conflate the 2. You like buses better than trains, fine. I’m the other way around. Mixing up operating and capital expenditures, as you do  your argument, is not illuminating. Whether Trimet builds light rail or not has nothing to do with its cost of operating buses.

            Your definition of “crony capitalism is much too broad for me. I define it to specific businesses getting special breaks due to their influence over pols. You seem to apply it to entire industries. Its a buzzword meant to show the virtues of enterprise completely free of any government interferance,regulatory or otherwise.

            Bowels Simpson had no chance ever because Republicans won’t increase taxes on the rich, which it would have required through elimination of loopholes. It was a non-starter. Obama was right to walk away from it. And Romney’s plan is mathematically flawed.

            The democrats HAVE represented the rich. As have the Republicans, only more so. That is why a bunch of young people are occupying public spaces all around the nation.  They are trying to re-boot the party that is supposed to represent working people.  The rich who are supporting Obama are probably trying to head off a revolution.

          • You say you are not mistaking liquidity for solvency, and then go on trying to explain why AAA rated CDOs became illiquid. How persuasive it that? The people who read these comments are waiting for you to explain why senior tranches have not defaulted. Why have so few mezzanine trances defaulted? Why do equity tranches default at a lower rate than junk bonds? The ability of these CDOs to manage risk is quite amazing. The ability of an OTC security of any kind to become illiquid should surprise no one. 

            The only real surprise came when Bear Stearns’ creditors were bailed out, but Lehman’s weren’t. That the repo market was unstable was well known. That the repo market was created by Glass Steagall is a fact you keep ignoring. That the less regulated banks outside the US like UBS, Deutchesbank, and Handelsbank had greater exposure to illiquid CDOs, but were not legally excluded from stable sources of credit, is a fact you keep ignoring. These facts are important, because when you try and blame the financial crisis on deregulation, the Financial Services Modernization Act is the only game in town, but it reduced risk and allowed the investment banking side of the crisis to get resolved without a bailout. These have got to be tough counterfactuals for you to swallow, perhaps that’s why you ignore them and repeat the magic word “deregulation” over and over again.

            There is something that I have mentioned several times that might also be considered deregulation, and you have not addressed it. Indeed it goes to the substance of my article above. The focus of government policy was not to maintain good underwriting practices; it was to expand home ownership. Wells Fargo was up to its neck in regulator pressure to lower its lending standards. It found ways to skirt these rules in a way that Citibank never did. Citibank was the poster boy of government policy compliance. Wells Fargo was not. Citigroup needed TARP to survive. Wells Fargo did not. Wells Fargo tried to opt out of TARP, so did Keycorp and US Bancorp. They were all forced to take TARP money so the banks that complied with government policy the previous decade would not be stigmatized. 

            The only way to get well managed banks to underwrite no doc loans, accept no down payment, and the relatively rare negative amortization loan that you refer to was to have them guaranteed by the GSEs. 

            Again we’ve seen this before. The best way to get three huge unprofitable transcontinental railroads whose bust brings great misery to so many is to give them Federal loan guarantees. The only way to get unprofitable solar manufacturers, who have to pay twice as much for rare earth metals, is to give them Federal loan guarantees. This massive distortion of the price of risk redirects capital and entrepreneurial effort toward unfruitful efforts, creating things that lose money.  

             I recall once suggesting to you that you start reading the Financial Times. If I remember correctly your response was “meh”, perhaps “meh” means you would rather watch movies and see how Gillian Tett, who writes for FT, responds to leading NPR questions like “when did bankers stop beating their wives?” When Tett says “Wall Street” you think Goldman Sachs and Wells Fargo when she refers to a financial product created by Fannie Mae and Freddie Mac. You cannot wrap yourself up in a blanket of vague causal claims, avoid detail, and be persuasive at the same time. 

            But then when you dip your toe into a cold hard fact, it does not support your position. No one is losing lawsuits because laws were not broken indeed. To say that better enforcement of the law was needed seems a bit absurd then does it not? 

            What about writing more laws? There is nothing in Dodd Frank that HARP Phase II cannot undermine. Dodd Frank slaps a heave regulatory burden on Wells Fargo, but leaves Fannie Mae untouched. That speech Obama gave in Las Vegas could have been given by George W. Bush. We are repeating the same mistakes. Where is the outrage?

            How could interest rates have been higher? This is Economics 101. Interest is the price of renting money. The price of renting money is determined by the supply of money relative to the demand for loans. Central banks lower interest rates by increasing the money supply. The Fed does this through the FOMC. They do not pass a law saying what interest rates should be, they create new money to buy assets to lower interest rates, and they raise interest rates by selling assets to take money out of circulation. 

            Remember the Capital Asset Pricing Model which won William Sharpe the Nobel Prize. Yield reflects risk. If you distort the price of renting money, risk averse lenders will take on too much risk. On a microeconomic level investors misperceive risk all the time, no big deal. Here we are talking about a macroeconomic monetary phenomena causing the systemic mispricing of risk. When the FOMC lowers interest rates it increases liquidity; when it raises rates it has the opposite effect. Look at what the Fed was doing in 2006-7. It was moping up the very liquidity it created. This simply does not happen in Sweden, Switzerland, Singapore, or Hong Kong. They don’t distort financial markets like we do, and they don’t suffer from endogenous shocks to the price of risk.

            Regarding light rail, the FAILURE to mix operating costs with capital costs is far less illuminating. There is an optimization point beyond which higher capital costs that attempt to lower operating costs yield a negative return on investment. If your goal is to waste money, ignore the principle of subsidiarity. Wasting money has consequences. Let’s not forget, fiscal policy with a spending multiplier less than 1 contracts GDP.

            I don’t see how your definition of crony capitalism is any more narrow than mine. I am comfortable with your definition: “specific businesses getting special breaks from their influence over pols.” Jim Hill’s Great Northern Railroad stands outside your definition just like mine, but the utter fiasco of the Union Pacific Railroad does not. Handelsbank does not get subprime Swedish mortgages cosigned by the Swedish taxpayer. They securitize CDOs without a hitch. This less regulated Handelsbank stands outside your definition but the highly regulated Citigroup does not. And then there are the GSEs.

            All 87 House freshmen Tea Party Republicans could not have blocked Bowles Simpson in the same way progressive Democrats in the House could not block NAFTA and the Urugway round of the GATT when Bill Clinton exerted Presidential leadership to push them through Congress. Timing is an element of leadership. Releasing a budget that DID NOT EVEN RAISE TAXES earlier this year, pretending like Bush/Cheney that deficits don’t matter and simply taking shots at Republican plans that took tough positions was a major strategic mistake for people who WANT to increase revenue. Even if he is reelected, he will face a Republican Senate. Even if Pelosi becomes Speaker, she has too many blue dog Democrats to stop any bill the establishment backs.  

            Regarding the control of both centrist parties by elites, we are in agreement. That this is changing you might not agree, but you’ll have to read my book. The occupier movement will not change this; evangelicals will. 

          • valley person

            Come on Eric. The only surprise was the Bear Sterns bailout and no bailout for Lehman? That’s it? The entire ball game? Again, you should consult the sources you cited. Maclean is clear as a bell on this point. By the time Bear and Lehman happened we were in double overtime in an unsustainable housing bubble. Blaming the particular pin that pricked the balloon is not systemic thinking. You should be ashamed of yourself for focusing so much on the end game.

            I really don’t understand your position on Glass Steagall.  It was repealed in 1999, before the bubble formed. How did an act that no longer existed play a role in the bubble and aftermath? And how can you say investment banks survived without bailouts when Lehman was an investment bank and did not survive? Bear Sterns needed what amounted to a bailout. And Merrill Lynch also did not survive. The investment banks were way over leveraged and toast once the bubble burst. 

            I don’t blame the financial crisis solely on deregulation. I’m saying it was a large contributing factor, which your own sources also say. What was a larger factor was the failure of the government to choose to create regulations for the emerging security instruments that allowed the bundling and sale of subprimes. Clinton was warned but Sumners and Rubin got their way.

            What I’m saying Eric, and what I know you can’t possibly agree with, is that the financial crisis was primarily a failure of the private finance system, aka capitalism. A private investment bubble burst and would have taken down the entire economy with it but for the TARP bailout. Government had programs to encourage widespread home ownership, yes, but it had been encouraging home ownership since at least the GI Bill of 1944.  The millions of veterans who took advantage were a huge share of the housing market thought he 50s. So why was there no housing bubble back then? Because the banks had not yet turned mortgage lending into a casino. And given the laws at that time, they couldn’t have even if they wanted to.

            (Countrywide Financial and a host of lenders were issuing all sorts of zero down loans with little or no government backup. They bypassed Fannie and Freddie for years and Mazillo bragged about that).

            The Gillian Tett interview was on Fresh Air, not NPR. There were no leading questions. Tett was given free space to articulate her position and to summarize at the end. Listen to it yourself. 

            “But then when you dip your toe into a cold hard fact, it does not
            support your position. No one is losing lawsuits because laws were not
            broken indeed. To say that better enforcement of the law was needed
            seems a bit absurd then does it not?”

            No, it doesn’t. Greenspan in particular chose to not employ the tools he had available to intervene by reigning in mortgage bundling, which he could have done. That does not mean laws were broken. It means he chose to let you financial geniuses play in your sandbox, make a lot of money, and put the entire national economy at risk.   

            “All 87 House freshmen Tea Party Republicans could not have blocked Bowles Simpson…”

            I suppose not. But lucky for them they have 155 other Republicans to vote along with them. Every blasted one has “taken the pledge” not to raise taxes. Bowles Simpson called for raising taxes to cover about 1/3 of the projected debt. So do the math. And watch the super committee. There will be zero R votes for any tax raising. 

            Clinton pushed NAFTA by relying on both Republican and conservative democratic votes. Obama would have gotten zero Republican votes for Bowles, and probably less than half of the Democrats. He would have been wasting his time walking that plank by himself. Look at what the Republicans did with the manufactured debt ceiling crisis. They were ready to scuttle the entire economy  to make their point. They walked away from a tax increase that was much less than Bowles had called for.

            That we are led by elites is probably a good thing Eric. The rabble, whether right or left, are proving themselves to be clueless. Your tea party caucus, led by raving lunatic Michelle Bachman, is ready to wreck the country to make some sort of point. I imagine a Kucinich led caucus would do the same with different idiotic policies.  I’m just hoping my elites (Buffett, Soros, Gates, Brin, Zuckerberg….) manage to beat your elites (Koch brothers, Coors, Hunt brothers…).

             

          • When I refer to the singularity of the incoherence of US policy toward Bear and Lehman I am of course referring to the investment banking side of this crisis which was fairly peripheral despite getting most of the attention. The US stand alone investment bank was a legacy of a uniquely American bad law, Glass Steagall. They were no less leveraged than UBS, Deutchebank, and Handelsbank. They had no more exposure to illiquid assets than the rest of the worlds’ investment banks, and they were no less solvent. These five legacy investment banks were dependent on the repo market and barred from the discount window. Glass Steagall had nothing to do with the real estate bubble. It simply made our investment banks unnecessarily vulnerable. 

            The Financial Services Modernization Act (FSMA) was less than a decade old in 2008. We were still path dependent on a business model it created. By the time of the crisis five investment banks remained having found the price of becoming normal banks, merging, and becoming members of the Federal Reserve System too costly. All national banks and bank holding companies are members of the Fed. Few state banks are, but they can join the Fed through a lengthy and costly process. The FSMA sets out a similar process. 

            As soon as FSMA went into effect Bear, Lehman, Merril, Morgan, and Goldman could have applied for membership, but chose not to do so. When Bear, Lehman, and Morgan desperately wanted access to the discount window in 2008, I don’t blame Bernake at all for telling them they can apply to become members just like any state bank, get in line, but there will be no loan first, application later. It was too late for Bear. Had it been allowed to default, the other four banks would have been forced sell themselves at fire sale prices to the many strong banks of the world ready to scoop them up. 

            Backing Bear’s creditors was an attempt to shore up the repo market. It was a mistake, subsidizing miscalculation on Dick Fuld’s part. John Thain was more perceptive, convincing Ken Lewis to buy Merrill. So then there were two. Morgan and Goldman had the cleanest balance sheets of any of their peers in the world, but they only had the repo market which froze the Monday that Lehman defaulted. The Fed waved their magic wand and made them members of the Federal Reserve and the mere access to the discount window thawed the repo market which they continue to use today. 

            None of this drama needed to take place had our financial system never been fractured so irrationally in the first place. No other country has gone out of their way to make relatively safe institutions more risky. In a sense, Glass Steagall lives on in Morgan and Goldman to this day. No Glass Steagall and no silly stand alone investment banks. 

            Again the investment banks were peripheral to the crisis. Even had they not all merged at fire sale prices, the worst that would have happened from their default would be that John Paulson would not be known for making the best trade ever but would simply be the majority shareholder of AIG rather than the US government. So investment banks did not need TARP; they simply needed the discount window. That is to say they needed to become bank holding companies – which is also to say they needed to stop being investment banks. Merrill merged; Morgan and Goldman got the same privileges that any solvent bank would get during a liquidity crisis, and there ended the investment banking side of the crisis, well before Nancy Pelosi ever brought TARP to a vote. None of these solutions would have been legal had FSMA never been pushed through Congress by my buddy Bill, but none of it would have been necessary had there never been a Glass Steagall Act. 

            The financial crisis was a commercial banking problem and continues to be. Hundreds of small, regional banks and credit unions have failed and continue to fail. The most recent was All American Bank of Des Plains, Illinois yesterday. They desperately needed their TARP money but won’t be paying it back now, nor will many more to come. They are failing the way banks used to fail before securitization. 

            Securitizaton which began in the 80s to save S+Ls has made our banking system safer. Less liquidity is not the answer. These banks that have been failing had such a small quota with the GSEs that their inventories bulged, making them look like the banking system we would have had if Lew Ranieri at Solomon Brothers never pioneered a way to give banks more liquidity.

            You continue to ignore how effective the CDOs have performed. That the bond desks of broker dealers traded them faster than they could read the prospectuses is inherent to any OTC product. That equity tranches have defaulted at a lower rate than junk bonds tells you how remarkable an innovation this was. These were heavily regulated products, falling under the Securities act of 1933. There was no fraud in their prospectuses, just as there was no fraud in the Toys.com IPO prospectus. There is a certain random walk to where an asset bubble will form. If you want risk averse money to stay away from risky financial products, then we need to allow our interest rates to reflect our low savings rate economy, rising to the point where widows and orphans can get a real return off a bank CD. 

            When it came to the cause of the crisis among commercial banks, real estate bubble, I gave you a systemic answer: The GSEs subsidized risk, the Federal Reserve kept interest rates too low for too long. With these two structural causes, banking regulations are as likely to prevent bad investments as drug laws are likely to prevent people from smoking pot. 

            To what extent do you think adding friction to securitization would have led to a better outcome? Reducing securitization only reduces the ability to manage risk. In that alternate world all our banks would look like the ones who are failing now. It would be like the S+L crisis on a grander scale. 

            Imagine there were no GSEs, it’s easy if you try. Angelo Mozzillo could experiment with subprime lending all he wants and fail. His losses would be relegated to a microeconomic event. No doubt payday lenders fail too. If there were GSEs to occupy the commanding heights of that market we could probable create an asset bubble from payday lenders too.

            With so much evidence that banking systems don’t have to suffer endogenous shocks like ours has, how could anyone think this is inherent to a banking system? How could anyone think that the collapse of the railroads that caused far more harm than even the recession we have had today, is inherent to the railroad business? The Great Northern Railroad demonstrated how a business without subsidy manages risk in a way that the three government backed boondoggles could not. Imagine if we really threw a massive slice of our society’s resources into an attempt to subsidize a huge solar panel industry. When the inevitable day came that we could no longer afford to support them and they all failed, who would think that was inherent to manufacturing?

            What have you got? – some vague notion that had Alan Greenspan done what no Fed Chairman has or will ever do, throw away the political independence of the Fed by turning it into an omnipotent banking czar, crossing into the lanes of the OTS, OCC, FDIC, and the SEC? Without any indication that the Fed would do any better a job than all these other agencies that monitor the most heavily regulated financial system in the world, the politicized monetary policy that would follow would be worse that the financial crisis we had. The Fed only enforces the discount window rules and conducts monetary policy, that’s a full plate. Again since no laws were broken what is a regulator to do? Since CDOs were highly regulated by the SEC, what should Greenspan do differently?

            Perhaps it is only a matter of semantics that has prevented me from saying that deregulation was a major factor in the crisis too. The way regulators intentionally lowered lending standards, heck they mandated it, and subsidized banks like Wells Fargo that put up resistance is often called deregulation. If not for that, what other deregulation was there besides FSMA? 

            This last decade was marked by a drop in lending standards toward home buyers like no other; I am comfortable calling that deregulation. There are huge structural inefficiencies that the series of housing policies since 1944 to promote home ownership have wreaked upon our economy. Perhaps you might identify sprawl as one of them. There are many more, but not even ten years ago Fannie Mae and Freddie Mac could only underwrite 80% of the assessed value of a home, creating a standardized 20% cushion. GSE purchasing of subprime mortgages did not occur until 2004 and I think that correlates rather well with a major theme of Bush’s reelection campaign in the same way HARP Phase II correlates to Obama’s.

            Regarding Bowles Simpson, you are forgetting how much establishment support there was for it (both your elites and my elites), plenty of room to pick off 60-70 Republicans. Greg Walden would have been one of them. The tax cut pledge has been around for a long time. Republicans have closed loopholes without raising marginal rates and gotten away with it. There are at least 80 Republicans who can sell a deal like Bowles Simpson in a contested primary. Don’t confuse what was possible then, with what developed later when the President would not engage on the issue and created the incentive to grandstand on the debt ceiling. The Republicans were able to go into the debt ceiling debate knowing they had the talking point that the President offered a budget that didn’t even raise taxes, that Senate Democrats voted down too. 

            Obama could have cut the Tea Party off at the kneecaps, and put the deficit issue behind him. Now he is in a box. The media will not let him get away with not having a real plan, but being too close to the election, he has to call for a level of tax revenue increases that will keep his demoralized base on board. It would have been worth it to cut deals last February. There were lots of horses to trade. Too late now. Too close to the election. 

            Banking on the elites reminds me of Nader’s book: Only the rich can save us.

          • valley person

            I’m with Stiglitz. The crisis was primarily a result of private banks, both commercial and investment, acting irresponsibly and recklessly. They failed to assess risk and properly allocate capital, shoving too much too fast at housing passed through individuals given time bomb loans. They did this because they could make a lot of money on the transactions, passing the risk to others.  He traces the problem to deregulation that began in 1980 with the S&Ls. THe bankers themselves lobbied for deregulation and got what they wanted from Republicans and Democrats. But the deregulation that allowed the banks to gamble left the taxpayers on the hook for when things went south.

            https://www.alternet.org/story/145773/joseph_stiglitz%3A_bankers_made_reckless_bets_on_the_economy,_knowing_taxpayers_were_going_to_pick_up_the_tab/?page=6

            Those young people out in the parks lack the details on this, but they know the system was corrupted by money. Privatized gains and socialized losses. Your argument, if I can try to summarize it, is that a completely deregulated system would be betterand would have avoided the crisis because the losses would not have been socialized, so the risks would not have been taken. Maybe so. I don’t doubt that had government not built an infrastructure of tax and other incentives to encourage home ownersip, then we might be a nation of renters like Spain or Germany, and have avoided this crisis as well as problems like suburban sprawl.

            But investors would simply find other bubbles. High tech (2000), beanie babies *1990s), gold (2011), the stock market (1929). There is too long a history of this to believe otherwise. Some of these bubbles don’t matter. Others create systemic risk. Which is why you financers need adult supervision. You chase short term profits without regard for the consequences to the rest of us.

            “Obama could have cut the Tea Party off at the kneecaps, and put the deficit issue behind him.”

            Sure. For that matter he could have submitted a balanced budget and called their bluff. But a balanced budget coming out of a financial crisis would raise unemloyment by another 5%. Obama thought that Boehner and cantor and McConnel were adults who would moderate the tea party and sign onto a compromise. He wanted them to put their offer on the table first, which is what a good negotiator does. They did this with the Ryan plan. Problem was the Ryan plan left no room to compromise because it dismantles a core safety net program. Obama could not agree to a 50% dismantling.

            Since then he has put reasonable offers on the table. A small tax rise on the richest among us in return for a larger cut in social programs. He gotten nothing for this but grief.

            “Banking on the elites reminds me of Nader’s book: Only the rich can save us.”

            He is right. The rabble can bring things down but can’t build things up. The tea party is a great example. OWS will probably become another if it lasts long enough. Anger and frustration are not constructive emotions.

          • To be persuasive in a forum like this you cannot merely cite links to some authority whom you think made a conclusion that you agree with. To be persuasive you need to articulate the premises yourself that lead to the conclusion you cling to. 

            If I recall correctly, you were fishing for a response to my question about what deregulation you are talking about when you cite deregulation as your primary causal condition for the crisis, a condition so materially significant that it was more determinative than the market distorting policies of the GSEs and the FOMC. In that link you gave me, Stiglitz only mentions two deregulations: Glass Steagall and a vague reference to the difference between banking in the 70s and 80s. Perhaps he is talking about the Carter Administration overturning Johnson Administration imposed price controls on savings account rates. 

            Really? that was the cause? What if they had not done so? Failure to allow banks to raise the interest that savers earn would have been far more devastating far more quickly. Failure to lift the cap for the S+Ls too made this quite clear. This is ironic is it not? Glass Steagall imposed unnecessary risks to our banking system too. He parries aside the opportunity to address this very reason why Paul Volker (no deregulator) rejects Glass Steagall like everyone else who understands how silly it was to arbitrarily limit investment banks to repo market financing and bar them from the discount window. I read Stiglitz’s book and recall him valuing Glass Steagall as an anti-trust tool! Could there be a more inefficient way to prevent mergers than imposing higher risks?

            Stiglitzs is a glaring example of the problem of the celebrity economist. He won the Nobel Prize for his work as a microeconomic specialist documenting asymmetric information in labor markets. He showed how a wasteful degree in Art History can land a person a job white collar job because it sends a signal to recruiters that you have the discipline to show up to class to graduate, even though the training had little vocational nature. He now claims he won his prize for proving the existence of market failure, and became a pundit advocating policies that assume that regulators are not subject to the problem of asymmetric information too. Glass Steagall, the Banking Act of 1966, and only repealing the price fixing for commercial banks but not thrifts are all acts of government failure. 
            Stiglitz also positions himself as having a banking background. He worked for the World Bank for a while until he became a lucrative stakeholder in the GSE industrial complex. That is to say, his entire professional experience in banking is in financing crony capitalism. Several times you have mentioned a lament that if left alone, bankers, driven by greed will enjoy private gains but public loss. I have agreed with you, but I directed such claims only to where it was due. There are probably few people who deserve the label of greedy banker more than Joseph Stiglitz. He is your source? This is the guy that wrote this white paper for Fannie Mae in 2002 arguing that new lower lending standards would pose virtually zero risk to taxpayers:

            https://online.wsj.com/public/resources/documents/stiglitzrisk.pdf

            Rather than restate other people’s conclusions, I invite you to engage the detailed premises that I provided you that led to mine. I also invite you to provide some premises of your own to support the conclusions that you restate. 

            This brings us back to deregulation. The folks who read these pages are still waiting for you to articulate a causal argument that deregulation had a material effect in the crisis. I have shown you how Glass Steagall added risk and the FSMA reduced it. 

            I have shown you how the heavily regulated securitization of mortgages into CDOs itself reduced risk. Despite getting TARP money, the banks that have been failing are the small regional banks and credit unions that had limited access to securitization giving us a glimpse at what kind of a systemic banking failure we would have had if all banks looked like them. I have introduced you to the fact that CDOs have not been defaulting as many people who shun details assume. Like any OTC financial product each CDO is too unique to be traded like a commodity in mass volume requiring stable financing for broker dealers who maintain inventories of them, and making them unsuitable for investors who cannot tolerate temporary illiquidity. 

            I have shown you why it is silly to assume the Federal Reserve could regulate CDOs better than the SEC, or why Alan Greenspan should have done what even Paul Volker never would do: throw away the political independence of the Fed. 

            I have shown you how the GSEs distort investor behavior (in Stiglitz’s 2002 paper he does too, but thinks it’s a good thing). 

            I have shown you how loose monetary policy creates the systemic mispricing of risk, inflating asset bubbles. 

            So given the market distorting policies of the GSEs and the Fed, what deregulation could possibly have prevented this crisis? Please identify the law and draft some premises that assert a causal explanandum to support your claim. 

            I gave you four examples of good banking systems that I suggest we emulate: Sweden, Switzerland, Singapore, and Hong Kong. They are barely regulated, have sound monetary policy, and no GSEs. Thus they avoid endogenous shocks to their economy. They don’t have bubbles like we do. Like us they face exogenous shock (Western Europe won’t be buying 40% of our exports next year like they did last year for example). Life will not be perfect, but life without the systemic mispricing of risk is better than what we have been doing. There is too much history of good financial systems to believe otherwise. 

            Don’t confuse a microeconomic phenomena like Beenie Babies with the macroeconomic. There are booms and busts in products within an economy all the time. You can probably model a business cycle in canvas Converse All Stars over the past 50 years as well. These will always be with us, but asset class bubbles are not inherent to banking. They require the distortion of the price of renting money or the distortion of the price of an individual investment’s risk. Distort both of those simultaneously and eventually a perfect storm is headed your way.

            Ironically for Stiglitz, the role of prices was core to his work. In the substance of his original research, he demonstrated that market failure always has a price distortion. What a terrible irony! Stiglitz bears more complicit responsibility for causing great harm on many people than the honest folks at Wells Fargo.

            Regarding the reason Obama missed the greatest chance to raise revenue and turn our ship of state into the storm that is coming our way, you hit upon the rational perfectly: avoidance of the inevitable austerity. It’s like that line from Augustine’s Confessions: “I prayed to God give me the will for chastity, but not yet.” Like Dick Fuld in 2007, Obama heads an over-leveraged institution that is focused on short-term results while ignoring the accumulation of long-term risk. He cannot imagine a scenario where his lenders will suddenly not buy his bonds. I hope Obama wins his bet. I would rather he wins reelection than we experience a flash crash in Treasuries. 

            There was nothing wrong with making the other guy make his offer first, but Obama never made a counter until recently at a campaign event. It is hard to remember now, but he had a working relationship with Paul Ryan. In good faith Ryan proposed a plan that took tough positions consistent with his ideology. Rather than do the same, Obama sent out the Democratic operatives to cut Ryan down while offering a budget that left no stakeholder behind. 

            Imagine another scenario. Obama released a budget like the one he touts at campaign rallies, takes hits from the right while Ryan takes hits from the left, they negotiate in good faith, and out pops Bowles Simpson, raising revenue from loop holes without raising marginal rates. Paul Ryan supports it. How could that not get 218 votes in the House? And who could possibly challenge Paul Ryan in a primary? How could Obama end up looking more Presidential? The blame for the effects of austerity would be carried by both parties in this very plausible bipartisan scenario. The rabble only bring things down indeed.

          • valley person

            See below to avoid text distortion. 

          • valley person

            ” When you say these are crap you seem to be confusing liquidity with solvency.”

            No. I’m saying that because according to the people you yourself cite, private lenders talked otherwise solvent individuals into signing up for time bomb mortgages so these could be sliced and diced, packaged with decent mortgages, and re-sold under phony AAA ratings to investors with far less detail on what was contained within. Mortgages had always been low liquidity investments but became otherwise through the bundling process. The bundles were highly liquid until they weren’t, which came as a shock.   And they no longer were because they were toxic and clearly declining rapidly in value. No one would touch them. And since the banks, investment and otherwise held so many of them, they (many of them) were on the verge of collapsing and the credit of the nation was in seizure.

            No, I lack the details. But that is the story line I got from your own cited sources. And I did not cherry pick. I listened to hour long interviews and saw a 2 hour film version of a book. The authors/film writers had every chance to offer your story line. But they did not. Or if they did it was buried deep enough that I did not detect it.

            According to Gillian Tett, again one of your own sources, the reason few are being prosecuted or sued successfully is that nearly all of this was perfectly legal. you should be making your detailed arguments to the authors you cited, who disagree with you, not waste them on the likes of me.

            The financial instruments were created by the investment banks, aka “wall street.” They found ways to securitize disparate mortgages and turn these into revenue. Yes, i use shorthand. Guilty as charged.

            “When liquidity dries up, prices drop. ”

            Yes, I suppose. But in this case the liquidity was based on rising prices, and when they peaked and started declining liquidity dried up. Or are we just arguing chicken and eggs here? The point is our financial system became over invested in a single commodoty. As long as money was being made all was great. As soon as the last fool came in the door the game was up. A classic bubble, which as I said there have been hundreds across the centuries of capitalism.

            Blaming the government for the logical consequences of private greed is disingenuous. The government’s failure was its decision to de-regulate and then look the other way. And it did so because of free market ideology of the government preceding and during the bubble.

            You say interest rates were “artificially low.” I’ve heard others make that claim. But what is “artificially low”? We had low inflation, other than in housing, from the late 90s through the bubble. THat would indicate production at or below capacity. Why should interest rates have been any higher in this period?

            “The Union Pacific, Central Pacific, and Northern Pacific railroads were the Milwaukee Light Rail like boondoggles of their day.”

            The former were private enterprises using government incentives to build private facilities the government wanted to help settle and knit together the west. The latter is an entirely public facility. I don’t see how you conflate the 2. You like buses better than trains, fine. I’m the other way around. Mixing up operating and capital expenditures, as you do  your argument, is not illuminating. Whether Trimet builds light rail or not has nothing to do with its cost of operating buses.

            Your definition of “crony capitalism is much too broad for me. I define it to specific businesses getting special breaks due to their influence over pols. You seem to apply it to entire industries. Its a buzzword meant to show the virtues of enterprise completely free of any government interferance,regulatory or otherwise.

            Bowels Simpson had no chance ever because Republicans won’t increase taxes on the rich, which it would have required through elimination of loopholes. It was a non-starter. Obama was right to walk away from it. And Romney’s plan is mathematically flawed.

            The democrats HAVE represented the rich. As have the Republicans, only more so. That is why a bunch of young people are occupying public spaces all around the nation.  They are trying to re-boot the party that is supposed to represent working people.  The rich who are supporting Obama are probably trying to head off a revolution.

          • valley person

            ” When you say these are crap you seem to be confusing liquidity with solvency.”

            No. I’m saying that because according to the people you yourself cite, private lenders talked otherwise solvent individuals into signing up for time bomb mortgages so these could be sliced and diced, packaged with decent mortgages, and re-sold under phony AAA ratings to investors with far less detail on what was contained within. Mortgages had always been low liquidity investments but became otherwise through the bundling process. The bundles were highly liquid until they weren’t, which came as a shock.   And they no longer were because they were toxic and clearly declining rapidly in value. No one would touch them. And since the banks, investment and otherwise held so many of them, they (many of them) were on the verge of collapsing and the credit of the nation was in seizure.

            No, I lack the details. But that is the story line I got from your own cited sources. And I did not cherry pick. I listened to hour long interviews and saw a 2 hour film version of a book. The authors/film writers had every chance to offer your story line. But they did not. Or if they did it was buried deep enough that I did not detect it.

            According to Gillian Tett, again one of your own sources, the reason few are being prosecuted or sued successfully is that nearly all of this was perfectly legal. you should be making your detailed arguments to the authors you cited, who disagree with you, not waste them on the likes of me.

            The financial instruments were created by the investment banks, aka “wall street.” They found ways to securitize disparate mortgages and turn these into revenue. Yes, i use shorthand. Guilty as charged.

            “When liquidity dries up, prices drop. ”

            Yes, I suppose. But in this case the liquidity was based on rising prices, and when they peaked and started declining liquidity dried up. Or are we just arguing chicken and eggs here? The point is our financial system became over invested in a single commodoty. As long as money was being made all was great. As soon as the last fool came in the door the game was up. A classic bubble, which as I said there have been hundreds across the centuries of capitalism.

            Blaming the government for the logical consequences of private greed is disingenuous. The government’s failure was its decision to de-regulate and then look the other way. And it did so because of free market ideology of the government preceding and during the bubble.

            You say interest rates were “artificially low.” I’ve heard others make that claim. But what is “artificially low”? We had low inflation, other than in housing, from the late 90s through the bubble. THat would indicate production at or below capacity. Why should interest rates have been any higher in this period?

            “The Union Pacific, Central Pacific, and Northern Pacific railroads were the Milwaukee Light Rail like boondoggles of their day.”

            The former were private enterprises using government incentives to build private facilities the government wanted to help settle and knit together the west. The latter is an entirely public facility. I don’t see how you conflate the 2. You like buses better than trains, fine. I’m the other way around. Mixing up operating and capital expenditures, as you do  your argument, is not illuminating. Whether Trimet builds light rail or not has nothing to do with its cost of operating buses.

            Your definition of “crony capitalism is much too broad for me. I define it to specific businesses getting special breaks due to their influence over pols. You seem to apply it to entire industries. Its a buzzword meant to show the virtues of enterprise completely free of any government interferance,regulatory or otherwise.

            Bowels Simpson had no chance ever because Republicans won’t increase taxes on the rich, which it would have required through elimination of loopholes. It was a non-starter. Obama was right to walk away from it. And Romney’s plan is mathematically flawed.

            The democrats HAVE represented the rich. As have the Republicans, only more so. That is why a bunch of young people are occupying public spaces all around the nation.  They are trying to re-boot the party that is supposed to represent working people.  The rich who are supporting Obama are probably trying to head off a revolution.

          • Watching movies and listening to interviews cannot substitute for delving into detail, because all one has to do is surf around for a favorite scene or a favorite conclusion that responds to a particularly leading question. That is why so much dialogue flees from detail, embracing sweepingly vague causal claims. Urban legends emerge, and bad policies get enacted that cause more harm than having no policies at all. Investment banking had nothing to do with the bank panic in 1932, but Glass Steagall separated it from commercial banking anyway. Let’s focus on detail.

            The way Glass Steagall led to the investment banking side of the crisis in 2008, which was very peripheral, but got most of the attention, should be very obvious. Investment banking which is far less risky than commercial banking was made dependent on the repo market and excluded from the discount window. No other economy in the world arbitrarily set itself up for failure like that. Its like “hey let’s take one of the least risky aspects of finance and make it as risky as possible!” 

            UBS, Deutchebank, and Handelsbank all had exposure to illiquid CDOs, indeed they had it worse and it remains worse than our Glass Steagall legacy American investment banks. Like Bear Stearns in March 2008, the rest of the world’s investment banks were and remain solvent, but unlike Bear Stearns, they were not legally excluded from a stable source of credit. We got a taste of the inevitable in 1998, the Clinton Administration had the leadership to do the right thing and push for the partial repeal of the worst banking law in US history. Had they not done so, the crisis would have been far worse. Had there never been a Glass Steagall Act, there would not have been an investment banking aspect of the crisis. The moment Morgan Stanley and Goldman Sachs were given access to the discount window, the investment banking side of the crisis was over – long before TARP. That is the most salient fact from Andrew Ross Sorkin’s book. If it did not make it into the screen play don’t blame the producers. 

            The problem was not that Lehman Brothers was allowed to fail. The problem was that the creditors of Bear Stearns were protected and not the creditors of Lehman Brothers which was twice Bear’s size. If the creditors of Bear Stearns would have been burned, Lehman Brothers would not have been able to float commercial paper to supplement their drying repo market, preventing Dick Fuld from playing hard to get with Robert Diamond.  You cannot jerk the money market around like that, without making things very worse very quick. 

            You keep ignoring the gorilla in the room, the GSEs. You listen to interviews where people refer to Wall Street, forgetting that is merely a term for the financial sector. The GSEs are Wall Street. So when you hear someone say “the financial instruments Wall Street created caused the financial crisis”, for you to claim that the GSEs cosigning the full faith and credit of the US taxpayer was not the material cause,  you have to make the absurd assumption that had it not been US policy to remove the risk from these assets, investors would have behaved the same way. 

            A subprime AAA CDO is only more risky than a prime AAA CDO for the GSEs not the “last fool it has been flipped” to. The fools here were the policy makers who were trying to distort the price of risk. The guy holding the CDO loses nothing more than temporary liquidity. 

            Something that people who shrug off details do not seem to understand is that AAA CDOs have not been defaulting. There have been high yield equity tranches that have defaulted, but surprisingly much less than one would expect, indeed they default at a lower rate than high yield corporate paper. I am sure a mezzanine tranch has defaulted somewhere even though it is so rare it never makes the news. When you say these are crap you seem to be confusing liquidity with solvency. 

            The reason the owners of CDOs are not winning big law suits against the originators of these financial products is that the products have performed as advertised. If you have ever seen a prospectus for a CDO you would know there are warnings all over the place that this is an OTC product and the dealer is not a market maker. 

            But if you did are not even aware that CDOs all have prospectuses then I can only imagine what you think when you hear Gillian Tett talking about investors not knowing what they own. This is the source of the liquidity problem in the mortgage market. If you want to sell Johnson and Johnson bonds, every bond is the same. They are a commodity. To have a liquid market you have to have an undifferentiated quality to each unit traded. Mortgages are unique to every home and homeowner. CDOs try to turn mortgages into a commodity. Every CDO has a detailed prospectus. The underwriting info and location are in every prospectus, as well as tranch seniority, but it is a time consuming process to go through and read it all, putting friction on the ability to quickly execute trades during a financial panic. When liquidity dries up, prices drop. This is very different from default. Financial institutions like UBS, Deutchebank, and Handelsbank with stable daily cash flow can deal with illiquid assets. 

            If you think this is bad compare it to its alternative. Small regional commercial banks and credit unions continue to fail. Unlike Wells Fargo, Keycorp, and US Bancorp, they will never pay back their TARP funds. Hundreds of these banks have failed because they had limited access to securitization. They could not manage their risk. Their assets were even less liquid. Securitization substantially reduced risk in the US financial sector. But the mortgage market would have been much smaller and its buyers would have shown greater due diligence had the price of risk not been distorted by the GSEs in the first place. 

            Think of a forest fire. The GSEs are like the forestry practices that create a more combustible forest, artificially low interest are like the global warming that creates the drought. When the price of risk is distorted, stopping the creation of an asset class bubble with tighter regulations is like trying to prevent forest fires with tighter anti-smoking regulations. You seem to be fleeing from the obvious in a quest to cling to some bumper sticker notion of what banking regulation can do. This clearly requires an unmistakable avoidance of detail.  

            Government power is so often abused by elites to carve anti-competitive moats against competition and rent seek against the public good that a cumbia disposition towards it leads to great harm. Glass Steagall is a good example. You list a few examples where government is obviously needed. Certainly we needed the government to conquer the Indians in acquiring the West, but not to build the railroads. That was a disaster; are you kidding?

            The Union Pacific, Central Pacific, and Northern Pacific railroads were the Milwaukee Light Rail like boondoggles of their day. They all went bankrupt stiffing the US Treasury’s loan guarantees. They also no doubt crowded out private ventures that would have cost the US treasury nothing. In case you do doubt that, the best built, and only original transcontinental railroad not to go bankrupt was the Great Northern Railroad, which ran from St. Paul to Seattle. James Hill was not politically connected so he built the Great Northern without subsidies. The lesson should be clear, that which is privately owned is properly cared for, but when the government distorts the price of risk it distorts the behavior of entrepreneurs. This was true of both railroad engineers who failed to scrutinize their costs and professional investors who failed to read prospectuses. 

            Most infrastructure probably needs to be financed by government. In this case the principle of subsidiarity should hold. Fortunately, article I section 8 of the constitution limits the federal government’s scope. When the people of New York wanted the federal government to finance the Erie Canal, James Madison who drafted article I’s language was President. He vetoed it claiming it was unconstitutional. The Erie Canal was a worthy project, and the State of New York financed it instead. 

            A cumbia disposition towards federal transportation spending has led to incredible waste once we forgot about enumerated powers. Tri-met has to limit bus frequency in east Portland, but they will go forward with spending $207 million a mile to connect Milwaukee with light rail which includes a huge, expensive, and grotesque statue that costs more than the price of  increasing the frequency of buses. When money is taxed in Oregon, sent to Washington DC in a leaky bucket only to be returned to Oregon for a stove-piped project, it is not free money, but Tri-Met behaves like it is. The opportunity costs are enormous. When it comes to opportunity costs, what you don’t know can hurt you. Check this out:
            https://www.oregonlive.com/portland/index.ssf/2011/10/trimet_facing_another_budget_g.html

            In addition to avoiding details, you shelter your arguments in a great deal of equivocation. When crony capitalism leads to failure its all the private sector. When government intervention leads to massive waste of society’s resources as in the great railroad bust, its the good old days of settling the west.

            It is a straw-man argument to say that a free market means the government will not protect people from the negative externalities of others, but a free market does require we restrain the government from causing negative externalities from its own policies. Distorting the price of risk in housing finance has not led to the losses that our railroad failures delivered US, but they might have had we never repealed Glass Steagall.

            Romney or Obama, with an evenly split house and a 51 seat Republican majority in the Senate: 2013 the year of austerity! Obama could have rammed Bowles Simpson through the present Congress in January, instead he offered a budget than neither cut spending OR RAISED TAXES, big missed opportunity. Hopefully the bond market will let us wait till 2013. 
             
            Regarding class correlation of party identification, I could have sworn you were trying to challenge a claim of mine that the Democrats have represented the political values of the rich, but that’s OK. Even though I wrote a book about this, I much prefer talking about crony capitalism.

          • Watching movies and listening to interviews cannot substitute for delving into detail, because all one has to do is surf around for a favorite scene or a favorite conclusion that responds to a particularly leading question. That is why so much dialogue flees from detail, embracing sweepingly vague causal claims. Urban legends emerge, and bad policies get enacted that cause more harm than having no policies at all. Investment banking had nothing to do with the bank panic in 1932, but Glass Steagall separated it from commercial banking anyway. Let’s focus on detail.

            The way Glass Steagall led to the investment banking side of the crisis in 2008, which was very peripheral, but got most of the attention, should be very obvious. Investment banking which is far less risky than commercial banking was made dependent on the repo market and excluded from the discount window. No other economy in the world arbitrarily set itself up for failure like that. Its like “hey let’s take one of the least risky aspects of finance and make it as risky as possible!” 

            UBS, Deutchebank, and Handelsbank all had exposure to illiquid CDOs, indeed they had it worse and it remains worse than our Glass Steagall legacy American investment banks. Like Bear Stearns in March 2008, the rest of the world’s investment banks were and remain solvent, but unlike Bear Stearns, they were not legally excluded from a stable source of credit. We got a taste of the inevitable in 1998, the Clinton Administration had the leadership to do the right thing and push for the partial repeal of the worst banking law in US history. Had they not done so, the crisis would have been far worse. Had there never been a Glass Steagall Act, there would not have been an investment banking aspect of the crisis. The moment Morgan Stanley and Goldman Sachs were given access to the discount window, the investment banking side of the crisis was over – long before TARP. That is the most salient fact from Andrew Ross Sorkin’s book. If it did not make it into the screen play don’t blame the producers. 

            The problem was not that Lehman Brothers was allowed to fail. The problem was that the creditors of Bear Stearns were protected and not the creditors of Lehman Brothers which was twice Bear’s size. If the creditors of Bear Stearns would have been burned, Lehman Brothers would not have been able to float commercial paper to supplement their drying repo market, preventing Dick Fuld from playing hard to get with Robert Diamond.  You cannot jerk the money market around like that, without making things very worse very quick. 

            You keep ignoring the gorilla in the room, the GSEs. You listen to interviews where people refer to Wall Street, forgetting that is merely a term for the financial sector. The GSEs are Wall Street. So when you hear someone say “the financial instruments Wall Street created caused the financial crisis”, for you to claim that the GSEs cosigning the full faith and credit of the US taxpayer was not the material cause,  you have to make the absurd assumption that had it not been US policy to remove the risk from these assets, investors would have behaved the same way. 

            A subprime AAA CDO is only more risky than a prime AAA CDO for the GSEs not the “last fool it has been flipped” to. The fools here were the policy makers who were trying to distort the price of risk. The guy holding the CDO loses nothing more than temporary liquidity. 

            Something that people who shrug off details do not seem to understand is that AAA CDOs have not been defaulting. There have been high yield equity tranches that have defaulted, but surprisingly much less than one would expect, indeed they default at a lower rate than high yield corporate paper. I am sure a mezzanine tranch has defaulted somewhere even though it is so rare it never makes the news. When you say these are crap you seem to be confusing liquidity with solvency. 

            The reason the owners of CDOs are not winning big law suits against the originators of these financial products is that the products have performed as advertised. If you have ever seen a prospectus for a CDO you would know there are warnings all over the place that this is an OTC product and the dealer is not a market maker. 

            But if you did are not even aware that CDOs all have prospectuses then I can only imagine what you think when you hear Gillian Tett talking about investors not knowing what they own. This is the source of the liquidity problem in the mortgage market. If you want to sell Johnson and Johnson bonds, every bond is the same. They are a commodity. To have a liquid market you have to have an undifferentiated quality to each unit traded. Mortgages are unique to every home and homeowner. CDOs try to turn mortgages into a commodity. Every CDO has a detailed prospectus. The underwriting info and location are in every prospectus, as well as tranch seniority, but it is a time consuming process to go through and read it all, putting friction on the ability to quickly execute trades during a financial panic. When liquidity dries up, prices drop. This is very different from default. Financial institutions like UBS, Deutchebank, and Handelsbank with stable daily cash flow can deal with illiquid assets. 

            If you think this is bad compare it to its alternative. Small regional commercial banks and credit unions continue to fail. Unlike Wells Fargo, Keycorp, and US Bancorp, they will never pay back their TARP funds. Hundreds of these banks have failed because they had limited access to securitization. They could not manage their risk. Their assets were even less liquid. Securitization substantially reduced risk in the US financial sector. But the mortgage market would have been much smaller and its buyers would have shown greater due diligence had the price of risk not been distorted by the GSEs in the first place. 

            Think of a forest fire. The GSEs are like the forestry practices that create a more combustible forest, artificially low interest are like the global warming that creates the drought. When the price of risk is distorted, stopping the creation of an asset class bubble with tighter regulations is like trying to prevent forest fires with tighter anti-smoking regulations. You seem to be fleeing from the obvious in a quest to cling to some bumper sticker notion of what banking regulation can do. This clearly requires an unmistakable avoidance of detail.  

            Government power is so often abused by elites to carve anti-competitive moats against competition and rent seek against the public good that a cumbia disposition towards it leads to great harm. Glass Steagall is a good example. You list a few examples where government is obviously needed. Certainly we needed the government to conquer the Indians in acquiring the West, but not to build the railroads. That was a disaster; are you kidding?

            The Union Pacific, Central Pacific, and Northern Pacific railroads were the Milwaukee Light Rail like boondoggles of their day. They all went bankrupt stiffing the US Treasury’s loan guarantees. They also no doubt crowded out private ventures that would have cost the US treasury nothing. In case you do doubt that, the best built, and only original transcontinental railroad not to go bankrupt was the Great Northern Railroad, which ran from St. Paul to Seattle. James Hill was not politically connected so he built the Great Northern without subsidies. The lesson should be clear, that which is privately owned is properly cared for, but when the government distorts the price of risk it distorts the behavior of entrepreneurs. This was true of both railroad engineers who failed to scrutinize their costs and professional investors who failed to read prospectuses. 

            Most infrastructure probably needs to be financed by government. In this case the principle of subsidiarity should hold. Fortunately, article I section 8 of the constitution limits the federal government’s scope. When the people of New York wanted the federal government to finance the Erie Canal, James Madison who drafted article I’s language was President. He vetoed it claiming it was unconstitutional. The Erie Canal was a worthy project, and the State of New York financed it instead. 

            A cumbia disposition towards federal transportation spending has led to incredible waste once we forgot about enumerated powers. Tri-met has to limit bus frequency in east Portland, but they will go forward with spending $207 million a mile to connect Milwaukee with light rail which includes a huge, expensive, and grotesque statue that costs more than the price of  increasing the frequency of buses. When money is taxed in Oregon, sent to Washington DC in a leaky bucket only to be returned to Oregon for a stove-piped project, it is not free money, but Tri-Met behaves like it is. The opportunity costs are enormous. When it comes to opportunity costs, what you don’t know can hurt you. Check this out:
            https://www.oregonlive.com/portland/index.ssf/2011/10/trimet_facing_another_budget_g.html

            In addition to avoiding details, you shelter your arguments in a great deal of equivocation. When crony capitalism leads to failure its all the private sector. When government intervention leads to massive waste of society’s resources as in the great railroad bust, its the good old days of settling the west.

            It is a straw-man argument to say that a free market means the government will not protect people from the negative externalities of others, but a free market does require we restrain the government from causing negative externalities from its own policies. Distorting the price of risk in housing finance has not led to the losses that our railroad failures delivered US, but they might have had we never repealed Glass Steagall.

            Romney or Obama, with an evenly split house and a 51 seat Republican majority in the Senate: 2013 the year of austerity! Obama could have rammed Bowles Simpson through the present Congress in January, instead he offered a budget than neither cut spending OR RAISED TAXES, big missed opportunity. Hopefully the bond market will let us wait till 2013. 
             
            Regarding class correlation of party identification, I could have sworn you were trying to challenge a claim of mine that the Democrats have represented the political values of the rich, but that’s OK. Even though I wrote a book about this, I much prefer talking about crony capitalism.

          • valley person

            I saw the move version of Sorkin’s book. Since Glass Steagall was repealled in 1999, I don’t know how that caused panic in 2007. Yes, letting Lehman go was stupid. And based on Sorkin’s movie, the stupidity was rooted in Paulson’s free market ideology. His character stated as much anyway.

            I have seen an interview with Bethany Mclean talking about her book and its findings. She said very clearly that the financial instruments Wall street created were the primary cause of the crisis. Once banks were able to off load subprime mortgages, the game changed and mortgages went from being low risk investments to high risk ones. Lenders stopped caring about the ability of the borrower to be able to pay for years on end. They even talked borrowers into higher risk ARMs who were well qualified for low risk 30 year conventionals because they (Washington Mutual in particular) could package the ARMs and re-sell them easier. Housing mortgages became a game of flipping to the next fool in the line. And record keeping was so sloppy that to this day no one really knows who owns what piece of which mortgage, evidenced by the foreclosure fiasco.

            Gillian Tett seems to confirm the role the financial instruments played in the crisis. (Interviewed on NPR). The risk of mortgages were transferred from individual institutions to the economy as a whole through the sale of bundled, largely crappy bits of subprime, the buyer of the crap having no idea who the mortgage holders were. All was fine while prices went up. Once the last fool rushed in, the game was up. Tett also points out that banks have a “utility” function in society. They aren’t like the local dry cleaners. That is why regulation and oversight is crucial. She talks about the “revolution” in finance that caught everyone off guard.

            Government policy to encourage home ownership was an enabler, but those policies were long standing. What really changed was the financial industry and its relationship to mortgages. It took private financial markets to make a mutton pie out of what had been a boring but stable business.  Government may have encouraged this, but did not do the deed. This was a private sector fiasco.

            “It requires a tremendous amount of faith to believe that government power can be directed for the public good.”

            No. It just takes some objective observation. Government power was essential to first acquiring and then settling the entire west, helped get the western railroads built, helped irrigate the land to allow farming, built dams to provide low cost hydro we still enjoy, set aside national forests and parks to protect our watersheds, wildlife, and have places to recreate, built clean water systems, educates our kids, and keeps the air reasonably clean among other things. To me, it takes a tremendous amount of faith to believe that unregulated, free market capitalism will result in more good than harm. And I say that as a private business consultant.

            Fact is Eric, we have a trillion dollar deficit. We aren’t going to come near to closing that unless the rich, and probably the rest of us, pay more in taxes. The last year, and current congressional super committee, should have shown everyone by now that we are not going to cut government spending enough. Republicans are fighting defense cuts, seniors will unelect anyone who cuts their benefits, and there isn’t enough left in other areas to make the difference. Ron Paul is not going to be president.

            I did not say the richest are becoming more Republican. They seem to be going the other way.  They went for Obama in 08, and unless the R’s nominate Romney, who is clearly one of them, they will probably stick with Obama.

          • valley person

            I saw the move version of Sorkin’s book. Since Glass Steagall was repealled in 1999, I don’t know how that caused panic in 2007. Yes, letting Lehman go was stupid. And based on Sorkin’s movie, the stupidity was rooted in Paulson’s free market ideology. His character stated as much anyway.

            I have seen an interview with Bethany Mclean talking about her book and its findings. She said very clearly that the financial instruments Wall street created were the primary cause of the crisis. Once banks were able to off load subprime mortgages, the game changed and mortgages went from being low risk investments to high risk ones. Lenders stopped caring about the ability of the borrower to be able to pay for years on end. They even talked borrowers into higher risk ARMs who were well qualified for low risk 30 year conventionals because they (Washington Mutual in particular) could package the ARMs and re-sell them easier. Housing mortgages became a game of flipping to the next fool in the line. And record keeping was so sloppy that to this day no one really knows who owns what piece of which mortgage, evidenced by the foreclosure fiasco.

            Gillian Tett seems to confirm the role the financial instruments played in the crisis. (Interviewed on NPR). The risk of mortgages were transferred from individual institutions to the economy as a whole through the sale of bundled, largely crappy bits of subprime, the buyer of the crap having no idea who the mortgage holders were. All was fine while prices went up. Once the last fool rushed in, the game was up. Tett also points out that banks have a “utility” function in society. They aren’t like the local dry cleaners. That is why regulation and oversight is crucial. She talks about the “revolution” in finance that caught everyone off guard.

            Government policy to encourage home ownership was an enabler, but those policies were long standing. What really changed was the financial industry and its relationship to mortgages. It took private financial markets to make a mutton pie out of what had been a boring but stable business.  Government may have encouraged this, but did not do the deed. This was a private sector fiasco.

            “It requires a tremendous amount of faith to believe that government power can be directed for the public good.”

            No. It just takes some objective observation. Government power was essential to first acquiring and then settling the entire west, helped get the western railroads built, helped irrigate the land to allow farming, built dams to provide low cost hydro we still enjoy, set aside national forests and parks to protect our watersheds, wildlife, and have places to recreate, built clean water systems, educates our kids, and keeps the air reasonably clean among other things. To me, it takes a tremendous amount of faith to believe that unregulated, free market capitalism will result in more good than harm. And I say that as a private business consultant.

            Fact is Eric, we have a trillion dollar deficit. We aren’t going to come near to closing that unless the rich, and probably the rest of us, pay more in taxes. The last year, and current congressional super committee, should have shown everyone by now that we are not going to cut government spending enough. Republicans are fighting defense cuts, seniors will unelect anyone who cuts their benefits, and there isn’t enough left in other areas to make the difference. Ron Paul is not going to be president.

            I did not say the richest are becoming more Republican. They seem to be going the other way.  They went for Obama in 08, and unless the R’s nominate Romney, who is clearly one of them, they will probably stick with Obama.

          • I am not sure finance is any more complex than any other aspect of an economy, but I am sure that anyone who does not take the time to master detail cannot draw sound conclusions about what happened in 2008 nor make persuasive policy prescriptions for the future. 

            There is a lot of literature available on the financial panic of 2008, a great deal of it lacks detail or credibility. There are four books that I would consider canonical, providing lucid analysis from facts gathered from primary sources and data and written for a general audience by established reporters: 

            1) The New York Times’ Andrew Ross Sorkin’s Too Big to Fail is a Bob Woodward like account of the panic among investment banks showing how Glass Steagal; made them vulnerable to panic in a way their global counterparts were not. He also shows how Graham Leach Bliley (has Graham’s name on it but there would be no Financial Services Modernization Act without Robert Rubin just as there would be no Sarbanes Oxley without Paul O’Neil) allowed mergers and the discount window to solve the problem long before TARP. Sorkin shows how TARP was needed to protect Citigroup and small regional banks, all of which should have been allowed to fail. And Sorkin hammers home the mistake of bailing out Bear Stearns’ creditors but not Lehman Brothers’. (this particular principle is salient right now as the ECB thinks Greece can be supported, but recognizes they can never raise enough capital to finance Spain, France, and Italy)

            2) The Financial Times’ Gillian Tett’s Fools Gold provides a very lucid narrative so that anyone should be able to understand why AAA rated CDOs became illiquid, but none have defaulted. There are a lot of smart people out there who are not aware of that fact. Walter Bagehot’s distinctions between illiquid and insolvent is very key here. That is the utility of the discount window, to deal with solvent institutions when they become illiquid during a panic. Probably the greatest misunderstanding out there was that Bear Stearns and Lehman Brothers were insolvent. 

            3) Joe Nocera’s All the Devils are Here and 4) Gretchen Morgensen’s Reckless Endangerment, both work for the New York Times and both pound the table hard on the point that no matter how draconian your regulatory policies, if the government allows GSEs to cosign the full faith and credit of the US taxpayer on to any form of debt, it will so distort market behavior by mispricing risk. Indeed it was Morgensen who gave me that analogy about the drug war. To say this is the result of natural market behavior is to say that Solyndra represents natural market behavior. 

            You are confusing crony capitalism with my free market position. The Clinton Administration was more free market orientated than the Bush Administration. I spelled out how they would have handled the crisis. This returns us to the substance of my article above. Here is Obama engaging in more crony capitalism. He is lowering lending standards to subsidize risk. That’s “more of the same” not “change we can believe in.” Where is the outrage?

            I love the blogoshpere, I really do, but its brevity cannot replace the detail that books from credible sources provide. “Once one understands the cause” does not mean they agree with me. It means they take the time to understand, to master detail. Had I not taken that time to read these and several others of lesser quality, I would have blamed this all on Greenspan too, for his counter-cyclical monetary policy. Heck, I run into really smart people all the time who have never cracked open an introductory economics textbook, and yet provide all manner of complex explanations for how recessions are caused and what gets us out of them. These four books should not be experts filtered out “by your tendencies.”

            Home ownership harms the middle class. It is as if the government subsidized gambling and alcoholism. People who own their homes pay more in rent that people who rent an apartment. If it were not subsidized, the market for quality middle class rental housing like the Swedish and German middle class enjoy would not be crowded out. Besides making us path dependent on more costly means of living, excessive home ownership also creates labor market inefficiencies by adding friction to relocation.

            That inflection point on the Case-Shiller index you identify has a rather obvious causal explanandum. Look at what interest rates were doing. The north star of finance is the risk free rate. Manipulate the risk free rate and you will create a systemic mispricing of risk. Risk averse money will buy assets with too much risk.

            Fortune’s rating of Bear Stearns was simply a ranking of its earnings. Anyone familiar with the Capital Asset Pricing Model would know this made Bear more risky an asset not less. When people make bad investment choices they should lose their shirts. This should be limited to mere microeconomic phenomena. The systemic mispricing of risk is not something that sound monetary policies in Sweden, Switzerland, Singapore, and Hong Kong have to deal with. All four of those countries have freer economies than we, even Sweden, as we discussed before, but they don’t face endogenous shocks from burst asset class bubbles. One does not have to be a “market fundamentalist” to observe the obvious. One would have to be somewhat versed in the fundamentals of economics I suppose. 

            It requires a tremendous amount of faith to believe that government power can be directed for the public good. When elites can use the coercive power of the state to compete rather than market forces, its execution serves the public good less than its voluntary transaction alternative. You identify problems caused by crony capitalism, fair enough, but it does not then follow support policies that will lead to more crony capitalism.

            It is no big deal from the perspective of the rich to pay more in taxes. They are at a point of satiation where they are giving the money away anyways. What you catch by asking more probing questions, like Charlie Rose does, is what they think of government spending. Warren Buffet is not always on message in this regard. When asked why he does not just write a larger check to the government himself, he does not respond with some rule of law answer, or even a concern that his own money will not be enough. Buffet points out that he has signed off all his wealth to the Bill and Melinda Gates Foundation which he sees as having a higher impact dollar per dollar on the needy than government spending. It is not that the rich need more money. Society needs the higher return on investment both for their financing of venture capital and more effective charity. Another common caveat I hear Charlie Rose elicit, is the desire to pay more in taxes if it would be guaranteed to pay down the debt. 

            Twelve years ago, I liked Bill Clinton’s rhetorical efforts to direct all surplus money to “save social security.” This was a great way of describing paying down the debt. The largest owner of Treasuries is the Social Security Administration. They don’t float in the open market, and often don’t get counted in debt calculations. When they begin to get cashed in around 2017, it will look identical to a regular Treasury auction. That seemed more sensible than the Bush tax cuts to me. I am of course making a political calculation that surpluses would continue to be directed in that sound way. There is a lot of evidence that my political calculation would be wrong. 

            I actually agree with your claim that the richest 1% are becoming more Republican; they just aren’t there yet. What “Republican” means is changing too. That is why I am focused on the factional dynamics within the two centrist parties, and why I spent the weekend “in the field” at Occupy Portland. Something big Gellman missed was how the religious right has been moving to the left on economics. Times they are a changing. 

          • valley person

            A lot of smart people have offered very detailed critiques of the whole mess and come to very different conclusions. So when you say “once one understands…” what you really mean is once one understands it the way you do Eric.  I admit I come at this with no expertise in finance, nor do I have a detailed knowledge of financial regulation. So I rely on the analysis of exerts filtered through my tendencies on whom to believe, as well as what is plausible rationally.

            Yes, Bush was one in a long line of Presidents dating back to Truman who pushed measures to increase home ownership. Everything from the GI Bill to the Federal Highway program to tax breaks for mortgage interest   and beyond have helped make the US a nation where home ownership is the norm rather than the exception. the government helped build a stable, middle class society as a result. But Case-Shiller has shown that housing prices tracked income growth almost exactly from 1900 right up until around 2000. At that point housing prices started diverging. This was before Bush did anything. Apparently the table had been set by others, including financial deregulation pushed by Phil Graham and signed by Clinton.

            It was private financial institutions who created zero down, zero initial interest mortgages predicated on continued rise in prices. It was private financial institutions who bundled these junk equities with regular ones in MBS instruments and sold these to other. largely foreign institutional investors. It was private insurance companies, notably AIG who insured all this mess. It was private bond raters who blessed the whole thing with ridiculous high ratings. It was private investors who chose to invest in mortgages. And it was Greenspan who chose to not use the powers of the fed to regulate or oversee it. He himself has admitted he erred by the way. He reflected the belief that the free market, unconstrained by government, would sort out the efficient allocation of capital. And it did. The market decided it had over allocated into housing. The only problem was that the correction took the whole economy down with it, and the financial geniuses that created the mess profited on both ends of the deal while the rest of us get to pay the party bill for years to come.

            Fortune by the way, rated Bear Sterns the best security firn in America a year before its collapse. I think that tells us where the center of gravity was in the investment world no?

            The housing bubble was a private sector phenomenon, and it was just the last in a long line of investment bubbles that end when the last fool rushes in the door. Blaming the government is a reflexive position for a free marketer. Sure, government sets policies that may induce investment in one or another economic sector. Defense comes to mind. But government does not decide where you or other investors choose to put your money. And they don’t create the instruments or manage the investments. If not housing then something else. There have been many, many investment bubbles over the course of the history of capitalism. Capital chases returns balanced against risk. And once a flood starts it creates its own momentum. Large bubbles threaten everyone else, which is why the only entity charged with looking out for the public interest, government, has to regulate. Free market fundamentalists will never accept this.

            As for the rest (party demographics), all good stuff. A poll the other day in the Times said 68% of the richest among us support raising taxes on themselves. What do you make of that, if it is accurate?

          • valley person

            This is something you might be interested in.  Ron Paul seems to have a lot of support among the OWS crowd.

            https://www.fordham.edu/images/academics/graduate_schools/gsas/elections_and_campaign_/occupy%20wall%20street%20survey%20results%20102611.pdf

          • This does show how Ron Paul has penetrated into university culture. Here is a picture I took from Occupy Portland last Friday:
            https://www.flickr.com/photos/[email protected]/6289769847/in/photostream

            As you can tell, I prefer polling and surveys that control for intensity of participation. I am a little concerned about a poll of a political protest where as many as 18% are not familiar enough with the Tea Party to decide whether to support them or not. Since they are giving away free meals, separating activists from the homeless is critical.

          • This does show how Ron Paul has penetrated into university culture. Here is a picture I took from Occupy Portland last Friday:
            https://www.flickr.com/photos/[email protected]/6289769847/in/photostream

            As you can tell, I prefer polling and surveys that control for intensity of participation. I am a little concerned about a poll of a political protest where as many as 18% are not familiar enough with the Tea Party to decide whether to support them or not. Since they are giving away free meals, separating activists from the homeless is critical.

          • This does show how Ron Paul has penetrated into university culture. Here is a picture I took from Occupy Portland last Friday:
            https://www.flickr.com/photos/[email protected]/6289769847/in/photostream

            As you can tell, I prefer polling and surveys that control for intensity of participation. I am a little concerned about a poll of a political protest where as many as 18% are not familiar enough with the Tea Party to decide whether to support them or not. Since they are giving away free meals, separating activists from the homeless is critical.

          • valley person

            This is something you might be interested in.  Ron Paul seems to have a lot of support among the OWS crowd.

            https://www.fordham.edu/images/academics/graduate_schools/gsas/elections_and_campaign_/occupy%20wall%20street%20survey%20results%20102611.pdf

  • Rupert in Springfield

    Let me give you the play by play on this a few years down the road. My record on predicting this sort of thing is pretty good, and if there is one thing I know it is the Democrat response to a situation, before the Democrats even know it.

    They have removed the LTV cap so now government exposure is increased. Now, Obama is considered a genius for this sort of thing. If you dare point out that this is exactly the kind of idiocy that got us into this mess several years ago they will call you a racist.

    If and when this goes south you will hear the traditional Democratic chant – “Deregulation is responsible, and the irresponsible Republicans and greedy banks are to blame”. If you point out Obama did it, back when he was being touted as a genius, there will be sudden complete ignorance.

    Don’t believe me?

    Let me point out the last Obama genius moment. Remember TARP?

    Yep, I thought you did.

    Well, it was only a few years ago that Obama was running around touted as a genius, bragging about how not only had he been getting TARP funds paid back by the banks, the government had turned a profit on the money.

    In other words, back then Obama was boy wonder because he learned how money obtained at 1% (Treasuries) and lent out at 5% (TARP) makes you a 4% profit. Even better when you put a gun to the banks head, force them to take the money and get a 10% preferred share in the bank to boot!

    Yep, all his supporters celebrated how smart Obama was.

    Now, these same people see absolutely no inconstancy in being down with the struggle with the Wall Streeters because the banks supposedly got bailed out.

    Yep, thats right, Now the money just a few years ago Obama was a genius for turning a profit on, was supposedly given away.

    So a few years from now, when HARP II really goes south the same people who claimed you hate poor people because you were against it, will then be saying it was a bailout for the rich and a Republican debacle of the highest order.

    • valley person

      You are legend in your own mind Rupert.

      “Don’t believe me?

      Let me point out the last Obama genius moment. Remember TARP?

      Yep, I thought you did.”

      Do you have some invisible friend you are talking to? Obama by the way, was not bragging about TARP repayments “a few years ago”, because “a few years ago” was when he was just elected, and TARP had not been paid back yet. Nevertheless, nearly all the funds dispersed, much less than the $700B allocated by the way, have been paid back. This is in contrast to the taxpayer funds  managed by Reagan-Bush during the S&L crisis, which were not paid back. So if he is bragging, he has earned the right. 

    • valley person

      You are legend in your own mind Rupert.

      “Don’t believe me?

      Let me point out the last Obama genius moment. Remember TARP?

      Yep, I thought you did.”

      Do you have some invisible friend you are talking to? Obama by the way, was not bragging about TARP repayments “a few years ago”, because “a few years ago” was when he was just elected, and TARP had not been paid back yet. Nevertheless, nearly all the funds dispersed, much less than the $700B allocated by the way, have been paid back. This is in contrast to the taxpayer funds  managed by Reagan-Bush during the S&L crisis, which were not paid back. So if he is bragging, he has earned the right. 

    • valley person

      You are legend in your own mind Rupert.

      “Don’t believe me?

      Let me point out the last Obama genius moment. Remember TARP?

      Yep, I thought you did.”

      Do you have some invisible friend you are talking to? Obama by the way, was not bragging about TARP repayments “a few years ago”, because “a few years ago” was when he was just elected, and TARP had not been paid back yet. Nevertheless, nearly all the funds dispersed, much less than the $700B allocated by the way, have been paid back. This is in contrast to the taxpayer funds  managed by Reagan-Bush during the S&L crisis, which were not paid back. So if he is bragging, he has earned the right. 

  • valley person

    New note to Eric. Citigroup just agreed to pay a $285M fine to settle a case where they sold toxic mortgage bundles and bet against them behind the scenes. Please explain how this was the government’s fault.

    • If Citigroup committed fraud, it would be a red herring argument on your part to think enforcement of criminal law is germane to our discussion about the way the price of risk gets distorted by monetary policy and government sponsored enterprises. Fraud does not need an asset class bubble to occur. 

      If this is like the Goldman case, then it is an example where simply acting as an intermediary to two trades taking an opposite bet is made out to be sinister for political purposes because the public will buy it. Goldman settled for pennies on the dollar, saving lawyers’ fees. $285m sounds so low, it might be that, but Citigroup was in such a desperate position, authentic fraud seems plausible enough to me. 

      • valley person

        What the citigroup case, and the earlier one against Goldman illustrate (to me) is the venal nature of the financial world, especially when you link those cases with insider trading and Maddoff like schemes. What they add up to is that greed is not so good after all, apologies to Gordon Gecko and Ayn Rand.

        The financial word did not simply act as mediators. They peddled a bad product to people they knew were high risk. They buried that risk with creative instruments they themselves designed. They then resold the risk  as low. And bet against the very loans they sold. And they took fees at every step.  In the end, millions lost their jobs and/or homes while the geniuses of finance misallocated the nations diminishing capital on a massive scale. Capital markets were supposed to know better. They didn’t. It will take us years to recover, and the right wing has the nerve to blame Obama, who is basically the guy holding a fire hose.

        I thank you Eric, for your detailed and respectful arguments. You have helped shed some new light on the issue for me. But you haven’t changed my mind. You have to lay the blame on government (GSEs) because it fits your larger narrative on the free enterprise system and the role of government. I have to go with Stigletz and Krugman and the others who place the primary blame on Wall Street greed because it fits my narrative.

        • valley person

          This is the response to Eric above:

          Eric writes: “To be persuasive in a forum like this you cannot merely cite links to some authority…”

          To restate my position:
          1) I am not an authority on banking and finance. Therefore, I cite others who are authorities and either agree or disagree with their analysis and conclusions. If that lacks persuasive power, so be it.

          2) You yourself cited 4 sources to bolster your argument. I consulted 3 of those sources. Two of them reached conclusions supporting my position (. The 3rd (Sorkin) focused on the immediate period of the crisis rather than the issues that led up to it.  McLean summarized her analysis of what led to the crisis exactly as I said she did: Failure to adopt new regulations to match the new financial instruments, failure to deal with the bubble early on, etc…You responded that I cherry picked McLean.

          3) Steiglitz, whom you also dismiss, makes persuasive arguments consistent with what McLean concluded. Krugman makes similar arguments. But as another Nobeler, what does he know?

          Eric writes: “If I recall correctly, you were fishing for a response to my question about what deregulation you are talking about when you cite deregulation as your primary causal condition for the crisis”

          You mistate my argument and then argue with your own mistatement. I stated just above your post quite clearly (or so I thought) that “the crisis was primarily a result of private banks, both commercial and investment, acting irresponsibly and recklessly. ”

          The regulatory failure was the  FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED YOU GUYS TO CREATE THIS MESS. Clinton was warned this could happen. Bush watched it happening before his eyes. The banks turned the mortgage industry into a casino, got way over leveraged in residential real estate, and went kaboom when the last fool rushed in.  As Krugman once stated, the derrivatives in effect allowed someone to buy insurance on the Titanic from a passenger on the Titanic.

          The Beanie Baby Bubble was not large enough to become a systemic threat. The Tulip Craze, just as ridiculous, did manage to bring the Dutch financial system down.   There have been many others over the years. Following the heard is a core characteristic of investment finance, and is exactly what happened. News to Greenspan apparently.
           
          Interesting that you point to Sweden as a good banking example for us. Didn’t they entirely nationalize their banks in the 90s after they became over extended in real estate? Why yes. I agree, we should have nationalized. 

          On Obama. Sure, someday US bonds could be shunned. He knows that. He also knows that “austerity” at the back end of a financial crisis is what Hoover did. Its a great way to take out yet another pound of flesh from those who had nothing to do with creating this mess, like the ones occupying Chapman Square.

          I’ll tell you what Eric. Lets get our austerity from the upper 1%, particularly the finance industry that brought us this mess, and go from there. Are you in?

           

          • There is nothing wrong with consulting sources when constructing your own arguments. To persuade the readers of these pages you have to actually construct arguments, not merely restate your sources’ conclusions. 
            Here is an argument called modus ponens: premise – If A then B, premise – A exists, and conclusion: B exists. It took two premises to construct this rather simple argument. I invite the readers of these pages to review your posts and count how many times you even had a premise. The facts and the details that I have used can all be found in those four books I mentioned. Notice that I was able to pick out all my facts from PROGRESSIVE authors whose opinions I have differed over the years, but have written very authoritative books that are descriptive rather than prescriptive. The ability to do that enhances one’s credibility. No need on my part to cite a celebrity pundit, even the many that agree with me that also have won the Nobel prize. Can you construct your arguments using facts from nonprogressive sources? If you can’t that’s fine. Premises leading to conclusions – that’s all we need. There is nothing wrong with cherry picking really. I can understand why you want to avoid Gretchen Morgensen for example even though she is the most left-wing economics writer for the New York Times, second only to Paul Krugman. It’s the picking of conclusions while leaving the supporting material to the imagination of the readers of these pages that we need to avoid.  And thus by all means there should be plenty of room for you to construct your arguments from all of those same authors I have used – just do use their premises as well. If you had done that, perhaps we would discover that they were not saying what you thought they said. When they say “Wall Street” you think Goldman Sachs when they are talking about a product created by Fannie Mae for example. When they talk about liquidity you think solvency etc. When you first mentioned Mclean you said this: “I have seen an interview with Bethany Mclean talking about her book and its findings. She said very clearly that the financial instruments Wall street created were the primary cause of the crisis.” So what instruments? What should have been done to said instruments? Who is Wall Street? If we are talking about Fannie Mae wouldn’t I agree with this? “Once banks were able to off load subprime mortgages” Off load them to who? The GSEs! How does this support your argument? “the game changed and mortgages went from being low risk investments to high risk ones.” What kind of risk are you talking about? liquidity risk or the risk of default? This is a very important distinction. It is hard for you or anyone to claim mortgages increased in risk from securitization since hardly any CDOs have defaulted while the banks lending the old fashioned way are failing by the hundreds still to this day. So this claim seems rather absurd regardless of who said it right? Can we agree on that? “Housing mortgages became a game of flipping to the next fool in the line. And record keeping was so sloppy that to this day no one really knows who owns what piece of which mortgage, evidenced by the foreclosure fiasco.” I pointed out to you that every CDO has a prospectus. Is she talking about the record keeping of the buyer or the seller? The CDO is a heavily regulated financial product covered under the Securities Act of 1933, making me rather certain we are talking about the buyer here. I am sure you are really losing sleep over the ability of mortgage owners to collect on their assets. What do we make of this? Did you miss how I tested this vague argument with some specific questions questions before? With loose monetary policy and the GSEs cosigning the full faith and credit of the US taxpayers, what regulation could possibly have led to a different outcome than the one we had? Keep in mind the CDO is a heavily regulated financial product. I also asked you if it were the case that we had less securitization and more old fashioned lending wouldn’t our banking system look more like the banks that are failing despite getting TARP money and less like the banks like Wells Fargo that tried to opt out of TARP to begin with? How would that have made things better? Now you are saying: “McLean summarized her analysis of what led to the crisis exactly as I said she did: Failure to adopt new regulations to match the new financial instruments, failure to deal with the bubble early on, etc” That is a little different, from before, but that’s OK. You place a little more emphasis on NEW regulations. But to make an argument you have to say what regulations. Failure to deal with the bubble? Hmm, sounds like something I would say regarding monetary policy. Was Mclean talking about monetary policy? Find me an economist that thinks a bubble can be formed without Fed induced liquidity. Find me an economist that thinks a bubble can be prevented with loose monetary policy. What did she suggest would dealt with the bubble, or heck forget about her, having learned from your sources, what do thing could have been done about the bubble?You have got to admit it is funny for you to be resting upon the authority of Stiglitz. That would be like me resting upon the authority of Dick Fuld or something, but I don’t care who you get your information from you cannot simply say he made convincing arguments without addressing how I showed you they were not so convincing. Let us recall what you said about Stiglitz: “I’m with Stiglitz. The crisis was primarily a result of private banks, both commercial and investment, acting irresponsibly and recklessly. They failed to assess risk and properly allocate capital, shoving too much too fast at housing passed through individuals given time bomb loans. They did this because they could make a lot of money on the transactions, passing the risk to others.  He traces the problem to deregulation that began in 1980 with the S&Ls.” Ok so all those bad things were caused by the deregulation that Stiglitz mentions in the interview. The interview mentioned only two. Any thinking person has to really scratch his head to see how these two acts of deregulation caused the crisis. More importantly, it is hard to see how the far worse crisis that the price controls themselves were causing at the time would not have been worse. I specifically addressed the rather bizarre assertion that Carter’s repealing a Johnson era price control scheme of savings account rates caused the financial crisis nearly three decades later. This was what you found convincing? The other regulation mentioned in the article was Glass Steagall. The interviewer asked Stiglitz if he agreed with Paul Volker, that Glass Steagall had to go. Stiglitz dodged the question choosing to talk about something else. Those were Stiglitz’s persuasive arguments regarding deregulation that you want the readers of these posts to be persuaded by? Seriously?But then after reminding us all of how persuasive Stiglitz was, its no longer about deregulation. Now its about (and you put it in capital letter so I don’t miss your pivot) a new position: “The regulatory failure was the  FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED YOU GUYS TO CREATE THIS MESS” Of course you claim this is not new position. I suppose that block quote in the paragraph above where you used the word “deregulation” it was a typo. I’m down with that, but this does not change the question I have been asking you over and over again: With the GSEs subsidizing the price of risk, and the Federal Reserve flooding our economy with excess liquidity leading to the systemic mispricing of risk. What new regulation would have prevented this crisis? How hard is that? The readers of these pages have been waiting. They are waiting for an argument, a conclusion supported by evidence. If I remember correctly, the only new regulation you have mentioned (twice) was that the Federal Reserve should have done more. There was something Alan Greenspan should of done but didn’t do. I twice explained why that was a bad idea. You twice ignored my response. Is that how you admit you were wrong? or do you have a good answer as to how the Fed with its full plate could have done the same work OCC, OTS, FDIC, and the SEC were already doing better. Do you really believe that they would be so much better regulators than all those other agencies that politicizing the Fed, throwing away its independence would be worth it? Why lay this all on Greenspan? Paul Volker wouldn’t have done this either. Nobody would. How do you conduct monetary policy without independence?The beenie babys not being a bubble is less about size than a matter of whether or not they constitute an asset class. If your only definition of a bubble is a product a lot of people suddenly want and then suddenly stopped wanting then we would be losing a great deal of analytic precision. From Beatles records to Atkins diet cookbooks sudden shifts in consumption patters are microeconomic in nature, not a bubble. As a macroeconomic phenomenon, the Tulip Bubble is very easy to separate from Beenie babies qualitatively not just quantitatively. As a major commodity for the Dutch economy before and long since, tulips attracted FDI for export. Investors made money off selling tulip farms and tulip tools. This investment in growing tulips for exports so far outstripped any reasonable expectation of the demand from abroad, the evidence for its monetary origin have been well documented. Also asset class bubbles spur inflation. I believe we talked about this before. Microeconomics and macroeconomics resemble each other of course. Both their demand curves slope down and both their supply curves slope up, but an individual product’s sudden rise and fall that in non-correlated to the business cycle don’t even materially effect GDP. When you say “news to Greenspan apparently” you seem to signal an acceptance that monetary policy causes asset class bubbles. Which leads us to the important counter-factual. What happens when a central bank pursues a stable money supply keeping it proportional to GDP growth? The answer is clearly no asset class bubbles. I have mentioned the four countries that have adopted this policy several times. You now mentioned Sweden. What about their banking crash? Glad you asked! We talked about Sweden before, how over the last twenty years it has steadily become more and more like Switzerland. Banking is no exception. But the beauty of this is that we have a comparison of Sweden before the crash and Sweden after the crash. The Sweden of most people’s imagination is that of the 70s – a fairly social democratic mixed economy. That economy not only had GSEs for housing, but for all manner of state financing of industry and an infrastructure bank. Its monetary policy was similar to China’s today, peging its currency to the ERM at too low a price. This fueled a real estate bubble and inflation.The election in 1991 was sort of a Swedish Tea Party revolt, except they got a Paul Ryan rather than a Susan O’Donnell. Under a parliamentary system without our checks and balances, Carl Bildt’s goal was to completely deregulate the financial system and eliminate all the GSEs. He took the entire financial sector over only to privatize them soon after, along with the post office and their version of social security. Sweden has avoided an endogenous shock ever since while we have had two. Singapore made its switch in 1998. Hong Kong and Switzerland have had stable monetary policy, no GSEs and virtually unregulated banks for more than a century, racking up a tremendous amount of evidence that asset class bubbles are not inherent to banking but contingent on government policy. “someday US bonds could be shunned” That is a statement that can be made the day before it happens. Did you know that the UK had a failed auction? Surprisingly few Americans know that.I am all for eliminating social security and medicare payments for the 1%. Let’s start there. 

          • valley person

            ” When you first mentioned Mclean you said this: “I have seen an interview
            with Bethany Mclean talking about her book and its findings. She said
            very clearly that the financial instruments Wall street created were the
            primary cause of the crisis.” So what instruments? What should have
            been done to said instruments? Who is Wall Street? If we are talking
            about Fannie Mae wouldn’t I agree with this? ”

            Sorry Eric. This is getting a bit tiresome. You know full well that “Wall street” is shorthand for the world of people, including yourself presumably, who live off of moving money around. It is not meant literally as only those who occupy offices in southern Manhatten.

            You also know what instruments, and I mentioned all 3. There are 3 categories I’m familiar with:

            1) Subprime mortgages, particularly zero down, zero interest time bombs
            2) Securitization, which allowed slicing, dicing, bundling, and selling mortgage packages instead of individual mortgages
            3) Derrivatives, which allowed insurance on the crap that couldn’t ever be covered. 

            My “modus ponens” has been stated multiple times, including in all caps just above your claim I didn’t make one. As far as what should have been done, in retrospect, Clinton should have taken the advice of his commodities chairwoman and developed reporting and regulatory requirements. Failing that, Bush should have done so. Failing that Greenspan should have stepped in with his authority to regulate banks.

            What we had was an ideology of free market capitalism leading to an unleashing of speculative finance, leading to an economic meltdown once the chosen speculative investment commodity (housing) ceased going up in value.

            This argument is supported by McLean, Tett, Krugman, and Stiglitz among many others.

            Fannie Mae by the way, was as much a part of the private finance system as were the banks. I get a kick out of those who pretend it was a government agency. It wasn’t. It was chartered and limited in scope by the government. But it was privately held and run.    

            “The readers of these pages have been waiting. They are waiting for an argument, a conclusion supported by evidence. ”

            I doubt it. They may be waiting for you to stop asking for the same arguments over and over. The conclusion has been made, the evidence provided. Move on Eric.

            Greenspan had the authority to prevent irresponsible lending practices happening under his nose. He stated that he erred in not using this authority because his belief in the “free market” told him that banks would not overly risk the capital of their investors.

            Brooksly Born fought for comprehensive regulation of derrivaties and credit default swaps. Greespan argued that there was no need, not even for anti-fraud provisions, because the market would prevent fraud from even happening. The private financial industry lobbied hard to prevent her from regulatiing within commodities.

            ” But to make an argument you have to say what regulations. Failure to
            deal with the bubble? Hmm, sounds like something I would say regarding
            monetary policy. Was Mclean talking about monetary policy? ”

            McLean summarized those, as did I. And yes, failure to deal with the bubble. But McLean pointed out that at the tail end of the bubble it was far too late.

            Look Eric, I’m burned out on this. I’ve stated and re-stated my argument. I’ve shown how my argument is backed up by your own sources, as well as 2 Nobel winners. Private financiers created and sold crappy mortgage instruments. They sliced and diced these into packages and re-sold them as low risk knowing full well they were high risk if and when prices stopped appreciating. They “insured” these crappy investments with crappy insurance that couldn’t possibly cover the cost. They did all this after having fought for deregulation AND prevention of new regulations for decades. They fueled a speculative bubble and in the end got bailed out. Meanwhile millions of people are out of work and deeply in debt.

            That is my story and I’m sticking to it. You have not shown me anything that convinces me of your narrative. Yes, government housing policy led to over investment in housing. It has done so since the 1950s at least. But what changed in the 90s was how banking treated housing and mortgages. End of my repeating arguments for you.

            “When you say “news to Greenspan apparently” you seem to signal an acceptance that monetary policy causes asset class bubbles”

            Monetary policy controls the supply of money through interest rates. What investors choose to do with low interest rates is up to them. Over investing in housing through the means they used is on them.

            “I am all for eliminating social security and medicare payments for the 1%. Let’s start there. ”

            Fine. Lets also eliminate the cap on their paying in while we are at it.

          • How could you possibly be tired? How hard has it been to keep claiming that someone out there made a great argument that you agree with regarding some vague notion about what should or should not have been done that would have prevented the crisis? Only now do things get interesting when you start unwrapping yourself from the safety blanket of vagueness. 

            Lo and behold the more precise we get with what Mclean actually said, the more you agree with me on evidence, but you still dogmatically cling to the same conclusions? For example, you said “Wall street is shorthand for the world of people, including yourself presumably, who live off of moving money around. It is not meant literally as only those who occupy offices in southern Manhattan.” You had been floating in a world of equivocation where I’m talking about the GSEs and you’re talking about “Wall Street” like it is something else. 

            Now, recognizing that Mclain sees the GSEs as the cause of the distortion in the price of risk that led to the “misallocation of capital” and thus the crisis, you change your tune claiming now that the GSEs, the Government Sponsored Enterprises, are “as much a part of the private finance system as were the banks. I get a kick out of those who pretend it was a government agency. It wasn’t. It was chartered and limited in scope by the government. But it was privately held and run.” Chartered by government – check. Limited in scope – check. Was privately held and run – check. 

            Nothing more to mention about the GSEs? Does their authority to cosign a subrime mortgage with the full faith and credit of the US taxpayer merit mention? Might their ability to float US treasury bonds to finance their operations make them slightly different than any other player on Wall Street? Could any of these other two distinctions help explain why the GSEs dominated the mortgage market to the point of BEING the mortgage market? Could the fact that they stayed out of subprime lending for years help explain why this crisis did not happen in the 60s let along the 90s? Could the fact the subprime market took off the moment the GSEs were directed to enter it be the reason you now want to declare Fannie Mae representative of a private banking system? Are you now admitting that the GSEs caused the crisis? Is that why you need to defy the obvious and make them out to be representative of the rest of the financial sector? 

            I brought to your attention what equivocation it is to attribute the problems caused by the market distorting policies of crony capitalism on to my free market position. You responded by giving the following definition of crony capitalism: “specific businesses getting special breaks due to their influence over pols.” Could there be any better example to fit into your own definition that the GSEs? 

            This distinction of yours is crucial because I have presented you repeatedly with the fact that there are several economies without GSEs that do not suffer all the problems you claim are inherent to a private banking system. It was only until the post before this one that you addressed this devastating counterfactual to those conclusions you keep restating. The example of Sweden presents you with an even more devastating counterfactual. We can compare the Sweden before 1991 to the undistorted, unfettered banking system of Sweden for the past two decades. I keep mentioning Handelsbank which is basically their JPMorgan. It was far less regulated than our five stand alone investment banks. It was more leveraged. It had greater exposure to CDOs, an OTC product that did what all OTC products do. They suddenly lost liquidity. This global housing bubble hit countries with GSEs and loose monetary policy not Sweden, Switzerland, Singapore, and Hong Kong. How do you account for this counterfactual? 

            Now you have isolated what you mean by “financial instruments” but that was not my question. I asked you what Mclean meant by “financial instruments” in those conclusions you attributed to her. Every time you claim somebody out there made a great argument, the same question applies. Nothing wrong with you agreeing with anyone’s conclusion and making it your own, but to turn it into an argument you have to share with us that person’s evidence too, not just their credentials.

            The Appeal to Authority did not become a recognized logical fallacy until Francis Bacon published The Novum Organum. Before Bacon, Galileo could find himself in an argument with a Jesuit about geocentrism sounding something like this. Galileo would say Jupiter has moons. The Jesuit would say no it does not. Galileo would say look into my telescope. The Jesuit would say, no you read Thomas Aquinas. Geocentrism is my story and I’m sticking too it. 

            To the extent you have been making a modus ponens argument it has been non sequitur, looking like this: Premise one: If an expert agrees with my assertion, then my assertion is true. Premise two: an expert does agree with my assertion. Conclusion: my assertion is true.  

            You did it rather blatantly just now: “modus ponens has been stated multiple times, including in all caps just above your claim I didn’t make one.” OK? here is what you put in caps: “FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED YOU GUYS TO CREATE THIS MESS.” I don’t see a premise in there. The rest of the paragraph rephrases the same assertion in the form of: Clinton failed, Bush failed, and then closes with a bizarre quote from Krugman implying it would be wrong for orphans whose parents died on the Titanic to collect a life insurance settlement. None of the other sentences are premises to support your assertion. 

            The only thing supporting your capital letter “argument” that you have provided us with so far is that ambiguous thing that Greenspan should have done but failed to do. I was very clear on the disadvantages and you have still ignored these counter argument for limiting the Fed to monetary policy and regulating the discount window. Why do you ignore counter arguments? 

            Although ignoring my counter argument, you did add somewhat to the Greenspan should of done more claim. Citing that Greenspan had the authority to “do something” you do not offer what he should have done. You also ignore the fact that in his October 2008 testimony before Congress, he explains how he was in fact “doing something” by providing expertise to the agencies that actually regulate lending. You have yet to explain to us why the Fed would be able to do this better than the OCC, OTS, FDIC, and the SEC. Since we are talking about a causal claim here, this is important. If the crisis could have been averted by this, you need to show evidence that there was something the Fed could have done that the other agencies were not already doing.

            The fact that Greenspan was surprised that CEOs take liberties with shareholder value I too found amusing at the time and still do, but I don’t see how this helps your argument. He was very clear in his testimony that derivatives were working as they were supposed to. And that is a point that I have been making here that has been so far met only with your silence. He did not as you claim state “that he erred in not using this authority because his belief in the free market” – another misrepresentation of a source on your part? This is what Waxman claimed and Greenspan denied it, attempting to explain to Waxman why the Fed leaves such matters to the regulatory agencies. Is that your causal explanandum? That the crisis would have been averted if the Fed engaged in consumer protection regulation? How would that have solved what was really inflating the bubble: predatory borrowing.

            Since the Greenspan could have done something assertion is obviously going no where you now provide us with Brooksly Born? Well at least this adds a second premise to your capital letters conclusion. You say she “fought for comprehensive regulation of derivatives and credit default swaps.” OK, I remember that, but don’t you have anything more to give us? There was no doubt some other person out there who fought hard for Glass Steagall giving us unusually risky stand alone investment banks limited to the repo market and barred from the discount window. There no doubt was someone who fought hard for the Banking Act of 1966 that gave us price controls on savings rates, threatening our banking system when interest rates spiked upwards in 1980. There no doubt was somebody who fought for excluding thrifts from the repeal of that law giving us the S+L crisis. Since Born’s proposal was shot down by everybody, and I mean everybody, don’t you think you have an obligation to articulate to us what it was she was going to do that would would have prevented the crisis without causing others as even the most heavy handed banking regulator in my lifetime, Arthur Levitt, opposed it it? It seems disingenuous to make this out to be a Greenspan thing. Rubin opposed it. Summers opposed it. Everybody opposed it. That does not mean it was wrong, but it certainly demands some evidence to convince the folks who read these posts that her idea had merit. 

            Here were the arguments against Born’s proposal. Don’t ignore these arguments. Don’t drop these arguments and just restate her name like it’s a magic word. You need to address these argument if you want to convince the readers of these posts that this indeed would have saved us. 

            1) Any attempt to put an OTC product on an exchange will create the illusion of liquidity. If you recall, this was the only problem we had with CDOs. The Commodity Futures Exchange trades commodities. Every soybean futures contract is identical. Every CDO is unique. They have not been defaulting like many people think, but they lost their liquidity. Most holders of CDOs expected this and were prepared. Had CDOs traded on an exchange, less CDO holders would have been prepared for a freeze. 

            2) The costs were and remain so prohibitive to trade OTC products in this way that it would make the CDO market impossible. Our financial crisis would have been far worse WITHOUT a CDO market than with the one we had. All our banks would look like the hundreds of small, regional institutions that continue to fail to this day despite getting TARP money. Instead we had banks like JPMorgan, Wells Fargo, US Bancorp, and Keycorp that did not even need TARP money. That is to say, our banking system would have looked like Sweden in 1991. 

            3) There is a derivative you probably never heard of called a hybrid. It too would be made cost prohibitive to trade on an exchange. The reason you have never heard of it is because it is less used in housing related finance, but provides an essential risk management tool for companies every day. There are many more OTC products you have never heard of but the unintended consequences of making them cost prohibitive are nontrivial. 

            4) Since Born had worked out few of the legal details, there was serous concern that the very act of setting up a regulatory body with its actual rules yet to be determined would cause a run on the existing OTC market. Economists call this “regime uncertainty.” 

            Those were just four very serious disadvantages that you will need to provide the readers of our posts evidence that Born’s proposal would not do more harm that what it was trying to solve. Given the track record of banking legislation in this country, this is a very important issue that you need to address. 

            You also need to provide us with some evidence that it would even have prevented the financial crisis to begin with. Don’t forget this has been a commercial banking crisis. None of the hundreds of banks that have failed and continue to fail to this day, deal in OTC products. Let’s phrase this in the form of the big question. With the GSEs distorting the price of risk in mortgage loan origination, and given that the Federal Reserve was systematically distorting the price of risk in the macroeconomy, do you have any evidence to persuade us that trading derivatives on a CFTC regulated exchange would have prevented the emergence of this asset class bubble in the first place? 

            If Born’s proposal would not solve for the real problem of the financial crisis, preventing the bubble in mortgage loan origination, would it at least have prevented the failure of AIG, or would it just have taken AIG’s business and given us another GSE in return? That is basically what its central exchange would amount to, a quasi government / private financial institution needing its own capital requirements. If its managers miscalculate on the scale that Fannie Mae did, who picks up the tab? What have you solved then?

            Regarding interest rates you said: “What investors choose to do with low interest rates is up to them. Over investing in housing through the means they used is on them.” This is a strange and less than lucid way to try and refute some rather established social science, but I am not even clear if you are even trying to deny that loose monetary policy creates asset class bubbles. It is so strange that you would be cagey on this issue. Sometimes you are for it; other times you downplay it. 

            Prices affect how investors choose to purchase financial products. Pension funds, University endowments, and charitable foundations need returns on their assets to finance their obligations. Not investing is not an option. The lower interest rates are the more risk they have to take to get a yield that will finance their obligations. In a low savings rate economy like our own, interest rates should be much higher than they have been since 1998, this would have allowed many risk averse investors to meet their financial needs with safer assets. Loose monetary policy makes the sale of financial products a seller’s market. 

            So then you close with something of a summery. This provides an opportunity to summarize the way you have been providing evidence to us along the way. You said: “I’ve stated and re-stated my argument.” As I pointed out above with that “argument” in capital letters, it is all assertion without supporting premises. So what you really mean is that you have stated and re-stated your conclusion. 

            “I’ve shown how my argument is backed up by your own sources, as well as 2 Nobel winners.” In addition to the logical fallacy of an appeal to authority, have you really shown how your argument is backed up by these sources? At the beginning of this post, we examined how shedding a little light on what Mclean actually said revealed that she was talking about the GSEs forcing you to suddenly blame all manner of woe they have caused on private banking. Then there are those times when I present counter-evidence against an assertion of yours, but you never engage it. You ignore it as if the readers of these pages did not notice it either, and then you restate the same assertion again later. How persuasive is that? 

            For example you say next: “Private financiers created and sold crappy mortgage instruments. They sliced and diced these into packages and re-sold them as low risk knowing full well they were high risk if and when prices stopped appreciating. They “insured” these crappy investments with crappy insurance that couldn’t possibly cover the cost.” Don’t these instruments have to be in default to be crappy? They became illiquid for about four months. How can you convince the readers of these posts that this is a bad thing when the alternative is worse. The small regional banks and credit unions outside of the CDO market have been illiquid for four years. Even with TARP money they are failing by the hundreds. This is the banking system you would prefer? one that cannot manage its risks? This fact destroys your “crap” claims. I have brought it up again and again, but you have not addressed this. You have also not addressed why these same financial products can be used in far less regulated countries, with sound monetary policy, and no GSEs without a financial crisis. 

            “They did all this after having fought for deregulation AND prevention of new regulations for decades.” OK so now we’re back to deregulation, but I cannot help but notice no causal assertion this time. Let’s pretend you did, just for the point of summery. The only evidence you provided for a deregulatory cause to the crisis, was that link to an interview with Joseph Stiglitz. In that interview he failed to identify any deregulation that caused the crisis beyond a romantic notion of sleepy Norman Rockwell banks in the 70s compared to the complexity of contemporary life. I assumed he meant the Banking Act of 1966, but I was guessing. That is to say, you gave us a link that you claimed contained supporting evidence and we had to guess how it might possibly support your conclusion that deregulation caused the financial crisis. Really? That was the best you could do? I gave you analysis showing why that deregulation could not possibly have caused the crisis, but rather the law was amended at the time to prevent a looming banking catastrophe. You have never responded to my counter argument you just restate your conclusion. Who is that supposed to convince? And then there is the great silver bullet from Brookley Born. We didn’t get any evidence but at least we got a name.  

            “That is my story and I’m sticking to it.” This is not a phrase that people confident in the truth value of their testimony make.  You do not have to dogmatically cling to the conclusions that you restate. 

            “You have not shown me anything that convinces me of your narrative.” It’s obvious I have. The way you show the readers you are convinced is by dropping arguments and ignoring my refutations of your assertions. 

             

          • How could you possibly be tired? How hard has it been to keep claiming that someone out there made a great argument that you agree with regarding some vague notion about what should or should not have been done that would have prevented the crisis? Only now do things get interesting when you start unwrapping yourself from the safety blanket of vagueness. 

            Lo and behold the more precise we get with what Mclean actually said, the more you agree with me on evidence, but you still dogmatically cling to the same conclusions? For example, you said “Wall street is shorthand for the world of people, including yourself presumably, who live off of moving money around. It is not meant literally as only those who occupy offices in southern Manhattan.” You had been floating in a world of equivocation where I’m talking about the GSEs and you’re talking about “Wall Street” like it is something else. 

            Now, recognizing that Mclain sees the GSEs as the cause of the distortion in the price of risk that led to the “misallocation of capital” and thus the crisis, you change your tune claiming now that the GSEs, the Government Sponsored Enterprises, are “as much a part of the private finance system as were the banks. I get a kick out of those who pretend it was a government agency. It wasn’t. It was chartered and limited in scope by the government. But it was privately held and run.” Chartered by government – check. Limited in scope – check. Was privately held and run – check. 

            Nothing more to mention about the GSEs? Does their authority to cosign a subrime mortgage with the full faith and credit of the US taxpayer merit mention? Might their ability to float US treasury bonds to finance their operations make them slightly different than any other player on Wall Street? Could any of these other two distinctions help explain why the GSEs dominated the mortgage market to the point of BEING the mortgage market? Could the fact that they stayed out of subprime lending for years help explain why this crisis did not happen in the 60s let along the 90s? Could the fact the subprime market took off the moment the GSEs were directed to enter it be the reason you now want to declare Fannie Mae representative of a private banking system? Are you now admitting that the GSEs caused the crisis? Is that why you need to defy the obvious and make them out to be representative of the rest of the financial sector? 

            I brought to your attention what equivocation it is to attribute the problems caused by the market distorting policies of crony capitalism on to my free market position. You responded by giving the following definition of crony capitalism: “specific businesses getting special breaks due to their influence over pols.” Could there be any better example to fit into your own definition that the GSEs? 

            This distinction of yours is crucial because I have presented you repeatedly with the fact that there are several economies without GSEs that do not suffer all the problems you claim are inherent to a private banking system. It was only until the post before this one that you addressed this devastating counterfactual to those conclusions you keep restating. The example of Sweden presents you with an even more devastating counterfactual. We can compare the Sweden before 1991 to the undistorted, unfettered banking system of Sweden for the past two decades. I keep mentioning Handelsbank which is basically their JPMorgan. It was far less regulated than our five stand alone investment banks. It was more leveraged. It had greater exposure to CDOs, an OTC product that did what all OTC products do. They suddenly lost liquidity. This global housing bubble hit countries with GSEs and loose monetary policy not Sweden, Switzerland, Singapore, and Hong Kong. How do you account for this counterfactual? 

            Now you have isolated what you mean by “financial instruments” but that was not my question. I asked you what Mclean meant by “financial instruments” in those conclusions you attributed to her. Every time you claim somebody out there made a great argument, the same question applies. Nothing wrong with you agreeing with anyone’s conclusion and making it your own, but to turn it into an argument you have to share with us that person’s evidence too, not just their credentials.

            The Appeal to Authority did not become a recognized logical fallacy until Francis Bacon published The Novum Organum. Before Bacon, Galileo could find himself in an argument with a Jesuit about geocentrism sounding something like this. Galileo would say Jupiter has moons. The Jesuit would say no it does not. Galileo would say look into my telescope. The Jesuit would say, no you read Thomas Aquinas. Geocentrism is my story and I’m sticking too it. 

            To the extent you have been making a modus ponens argument it has been non sequitur, looking like this: Premise one: If an expert agrees with my assertion, then my assertion is true. Premise two: an expert does agree with my assertion. Conclusion: my assertion is true.  

            You did it rather blatantly just now: “modus ponens has been stated multiple times, including in all caps just above your claim I didn’t make one.” OK? here is what you put in caps: “FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED YOU GUYS TO CREATE THIS MESS.” I don’t see a premise in there. The rest of the paragraph rephrases the same assertion in the form of: Clinton failed, Bush failed, and then closes with a bizarre quote from Krugman implying it would be wrong for orphans whose parents died on the Titanic to collect a life insurance settlement. None of the other sentences are premises to support your assertion. 

            The only thing supporting your capital letter “argument” that you have provided us with so far is that ambiguous thing that Greenspan should have done but failed to do. I was very clear on the disadvantages and you have still ignored these counter argument for limiting the Fed to monetary policy and regulating the discount window. Why do you ignore counter arguments? 

            Although ignoring my counter argument, you did add somewhat to the Greenspan should of done more claim. Citing that Greenspan had the authority to “do something” you do not offer what he should have done. You also ignore the fact that in his October 2008 testimony before Congress, he explains how he was in fact “doing something” by providing expertise to the agencies that actually regulate lending. You have yet to explain to us why the Fed would be able to do this better than the OCC, OTS, FDIC, and the SEC. Since we are talking about a causal claim here, this is important. If the crisis could have been averted by this, you need to show evidence that there was something the Fed could have done that the other agencies were not already doing.

            The fact that Greenspan was surprised that CEOs take liberties with shareholder value I too found amusing at the time and still do, but I don’t see how this helps your argument. He was very clear in his testimony that derivatives were working as they were supposed to. And that is a point that I have been making here that has been so far met only with your silence. He did not as you claim state “that he erred in not using this authority because his belief in the free market” – another misrepresentation of a source on your part? This is what Waxman claimed and Greenspan denied it, attempting to explain to Waxman why the Fed leaves such matters to the regulatory agencies. Is that your causal explanandum? That the crisis would have been averted if the Fed engaged in consumer protection regulation? How would that have solved what was really inflating the bubble: predatory borrowing.

            Since the Greenspan could have done something assertion is obviously going no where you now provide us with Brooksly Born? Well at least this adds a second premise to your capital letters conclusion. You say she “fought for comprehensive regulation of derivatives and credit default swaps.” OK, I remember that, but don’t you have anything more to give us? There was no doubt some other person out there who fought hard for Glass Steagall giving us unusually risky stand alone investment banks limited to the repo market and barred from the discount window. There no doubt was someone who fought hard for the Banking Act of 1966 that gave us price controls on savings rates, threatening our banking system when interest rates spiked upwards in 1980. There no doubt was somebody who fought for excluding thrifts from the repeal of that law giving us the S+L crisis. Since Born’s proposal was shot down by everybody, and I mean everybody, don’t you think you have an obligation to articulate to us what it was she was going to do that would would have prevented the crisis without causing others as even the most heavy handed banking regulator in my lifetime, Arthur Levitt, opposed it it? It seems disingenuous to make this out to be a Greenspan thing. Rubin opposed it. Summers opposed it. Everybody opposed it. That does not mean it was wrong, but it certainly demands some evidence to convince the folks who read these posts that her idea had merit. 

            Here were the arguments against Born’s proposal. Don’t ignore these arguments. Don’t drop these arguments and just restate her name like it’s a magic word. You need to address these argument if you want to convince the readers of these posts that this indeed would have saved us. 

            1) Any attempt to put an OTC product on an exchange will create the illusion of liquidity. If you recall, this was the only problem we had with CDOs. The Commodity Futures Exchange trades commodities. Every soybean futures contract is identical. Every CDO is unique. They have not been defaulting like many people think, but they lost their liquidity. Most holders of CDOs expected this and were prepared. Had CDOs traded on an exchange, less CDO holders would have been prepared for a freeze. 

            2) The costs were and remain so prohibitive to trade OTC products in this way that it would make the CDO market impossible. Our financial crisis would have been far worse WITHOUT a CDO market than with the one we had. All our banks would look like the hundreds of small, regional institutions that continue to fail to this day despite getting TARP money. Instead we had banks like JPMorgan, Wells Fargo, US Bancorp, and Keycorp that did not even need TARP money. That is to say, our banking system would have looked like Sweden in 1991. 

            3) There is a derivative you probably never heard of called a hybrid. It too would be made cost prohibitive to trade on an exchange. The reason you have never heard of it is because it is less used in housing related finance, but provides an essential risk management tool for companies every day. There are many more OTC products you have never heard of but the unintended consequences of making them cost prohibitive are nontrivial. 

            4) Since Born had worked out few of the legal details, there was serous concern that the very act of setting up a regulatory body with its actual rules yet to be determined would cause a run on the existing OTC market. Economists call this “regime uncertainty.” 

            Those were just four very serious disadvantages that you will need to provide the readers of our posts evidence that Born’s proposal would not do more harm that what it was trying to solve. Given the track record of banking legislation in this country, this is a very important issue that you need to address. 

            You also need to provide us with some evidence that it would even have prevented the financial crisis to begin with. Don’t forget this has been a commercial banking crisis. None of the hundreds of banks that have failed and continue to fail to this day, deal in OTC products. Let’s phrase this in the form of the big question. With the GSEs distorting the price of risk in mortgage loan origination, and given that the Federal Reserve was systematically distorting the price of risk in the macroeconomy, do you have any evidence to persuade us that trading derivatives on a CFTC regulated exchange would have prevented the emergence of this asset class bubble in the first place? 

            If Born’s proposal would not solve for the real problem of the financial crisis, preventing the bubble in mortgage loan origination, would it at least have prevented the failure of AIG, or would it just have taken AIG’s business and given us another GSE in return? That is basically what its central exchange would amount to, a quasi government / private financial institution needing its own capital requirements. If its managers miscalculate on the scale that Fannie Mae did, who picks up the tab? What have you solved then?

            Regarding interest rates you said: “What investors choose to do with low interest rates is up to them. Over investing in housing through the means they used is on them.” This is a strange and less than lucid way to try and refute some rather established social science, but I am not even clear if you are even trying to deny that loose monetary policy creates asset class bubbles. It is so strange that you would be cagey on this issue. Sometimes you are for it; other times you downplay it. 

            Prices affect how investors choose to purchase financial products. Pension funds, University endowments, and charitable foundations need returns on their assets to finance their obligations. Not investing is not an option. The lower interest rates are the more risk they have to take to get a yield that will finance their obligations. In a low savings rate economy like our own, interest rates should be much higher than they have been since 1998, this would have allowed many risk averse investors to meet their financial needs with safer assets. Loose monetary policy makes the sale of financial products a seller’s market. 

            So then you close with something of a summery. This provides an opportunity to summarize the way you have been providing evidence to us along the way. You said: “I’ve stated and re-stated my argument.” As I pointed out above with that “argument” in capital letters, it is all assertion without supporting premises. So what you really mean is that you have stated and re-stated your conclusion. 

            “I’ve shown how my argument is backed up by your own sources, as well as 2 Nobel winners.” In addition to the logical fallacy of an appeal to authority, have you really shown how your argument is backed up by these sources? At the beginning of this post, we examined how shedding a little light on what Mclean actually said revealed that she was talking about the GSEs forcing you to suddenly blame all manner of woe they have caused on private banking. Then there are those times when I present counter-evidence against an assertion of yours, but you never engage it. You ignore it as if the readers of these pages did not notice it either, and then you restate the same assertion again later. How persuasive is that? 

            For example you say next: “Private financiers created and sold crappy mortgage instruments. They sliced and diced these into packages and re-sold them as low risk knowing full well they were high risk if and when prices stopped appreciating. They “insured” these crappy investments with crappy insurance that couldn’t possibly cover the cost.” Don’t these instruments have to be in default to be crappy? They became illiquid for about four months. How can you convince the readers of these posts that this is a bad thing when the alternative is worse. The small regional banks and credit unions outside of the CDO market have been illiquid for four years. Even with TARP money they are failing by the hundreds. This is the banking system you would prefer? one that cannot manage its risks? This fact destroys your “crap” claims. I have brought it up again and again, but you have not addressed this. You have also not addressed why these same financial products can be used in far less regulated countries, with sound monetary policy, and no GSEs without a financial crisis. 

            “They did all this after having fought for deregulation AND prevention of new regulations for decades.” OK so now we’re back to deregulation, but I cannot help but notice no causal assertion this time. Let’s pretend you did, just for the point of summery. The only evidence you provided for a deregulatory cause to the crisis, was that link to an interview with Joseph Stiglitz. In that interview he failed to identify any deregulation that caused the crisis beyond a romantic notion of sleepy Norman Rockwell banks in the 70s compared to the complexity of contemporary life. I assumed he meant the Banking Act of 1966, but I was guessing. That is to say, you gave us a link that you claimed contained supporting evidence and we had to guess how it might possibly support your conclusion that deregulation caused the financial crisis. Really? That was the best you could do? I gave you analysis showing why that deregulation could not possibly have caused the crisis, but rather the law was amended at the time to prevent a looming banking catastrophe. You have never responded to my counter argument you just restate your conclusion. Who is that supposed to convince? And then there is the great silver bullet from Brookley Born. We didn’t get any evidence but at least we got a name.  

            “That is my story and I’m sticking to it.” This is not a phrase that people confident in the truth value of their testimony make.  You do not have to dogmatically cling to the conclusions that you restate. 

            “You have not shown me anything that convinces me of your narrative.” It’s obvious I have. The way you show the readers you are convinced is by dropping arguments and ignoring my refutations of your assertions. 

             

        • You assume many facts not in evidence, and I’m not talking about the court case. 

          Claims of the “venal nature of the financial world” have a long history. It has its roots in religion and romanticism but certainly not reason. It ultimately comes from people who enjoy the fruits of living in a world that has successfully connected people with savings with people with ideas to do far more good than any other financial system in human history, but then imagine an alternative world of agape that does not exist. This primarily dwells in the realm of normative thought. A little analytic sunshine usually disinfects such prejudice. 

          To confuse the ability of acting as a medium of exchange between one person who thinks something will rise in value to another person who thinks something will drop in value with Madoff-like fraud, seems more like a willful act of equivocation than a rational position. Not only is it a disservice to both the long and the short investor, it is a disservice to people who are intentionally trying to incur a loss to hedge. 

          Let me give you an example of a trade I had been making from the spring of 2006 to the end of 2008 where I intentionally made investments that I knew would lose money. This is called a market neutral position. The coming collapse of the housing bubble was obvious to me in 2005 as it was to many people yourself included, but that is not enough information. One can lose one’s shirt being right too early. I made a recession play against manufacturing. I made an airline play against stagflation. I tried but could never construct a market neutral trade on home builders. My best however was my play on the financial sector. 

          It was not rocket science. I needed four companies: the best and worst investment bank and the best and the worst integrated bank. I shorted Bear Stearns and was long Goldman Sachs. I shorted Citigroup and was long Wells Fargo. I did this in many ways, from credit instruments, options, and through ownership and borrowing of the stocks to sell them short. When all financial services companies went up in 2006, I intentionally lost money on my short position. When they finally all dropped like rocks two years later, I intentionally lost money on my long positions. I made money for my partners in the spread between the good and the bad. My primary metric for separating the good from the bad was a ratio of super senior tranches in special investment vehicles relative to short-term liabilities. The multiple instruments I used were non-correlated so together they reduced risk even further. There is simply nothing evil about protecting real people’s savings from risk. 

          The Investment Company Act of 1940 prevents mutual funds from doing this. By law only “accredited investors” are allowed to manage their risk in any meaningful way. The many folks who have been legally limited to put up with their heavily regulated mutual funds lost their shirts more because their options to hedge were limited than the behavior of capital markets were unpredictable. A janitor in Singapore can save money at a high rate of return with less risk than a small investor in the US. The Singapore janitor just deposits cash in his local bank opting for a certain kind of savings account, enjoying 8% a year tax free and well hedged. Remind me why we have a low savings rate in the US. When was the last banking crisis in Singapore? 

          So who is the Investment Company Act of 1940 supposed to protect? The answer is banks, from competition with other banks. As you ponder whether greed is good after all, perhaps you should ponder if greed is ever absent. Corporations use regulatory policy to carve out anti-competitive moats. The natural default position of a regulator is to be pro-industry. No matter how much campaign finance law a political culture has, this will always be the case. Industry and regulators work together to restrain competition and keep their mutual bread buttered. The subsidies, price distortion, and inefficiencies that follow hurt society more than market forces. Regulators are greedy. Politicians are greedy. Bankers are greedy. But greed backed up by the coercive power of the state brings more harm than greed backed up by voluntary transaction. To see this in concrete terms, one only has to compare the US financial system which is the most heavily regulated in the world with its global counterparts which are not. 

          To peddle products that were known to be highly risky ignores the fact that they peddle products that manage the risk. Ultimately consumers of financial products choose what they buy, some with more due diligence than others. Banks “buried risk in complicated instruments.” That is a good thing. They bury risk by hedging it. That is why CDOs have worked exactly as they were intended. Find me a super senior tranche that has missed a coupon payment. 

          When you blame the recession on bankers, it looks like you are grasping for a scapegoat. Like medieval peasants who don’t understand that spinster lady’s alternative medicine, the plague must be her fault! Remember this scene from Monty Python’s Holy Grail:

          “Ok we did do the GSE guarantee and the liquidity, but she’s a witch!”

          “She turned me into a debtor! …. I got better.”

          I don’t know about the right wing, but the only thing I am blaming Obama of doing it lowering lending standards below where they were before crisis at the expense of the taxpayer. Do you support having no assessments, no debt to value ratio, no buy back provisions to keep the greedy bankers honest?

          There is no reason that you have to be trapped into predetermined thinking. I do not blame everything on the GSEs because of a larger narrative. Their causal role comes from their large position at the commanding heights of the mortgage market distorting the price of risk. One has to be extremely ideological to run away from such a material fact, when the GSEs lending policies and leverage changed so dramatically from 2002 to the crisis while economies without these policies enjoy more stability. 

           

          • valley person

            Your investment approach sounds to me like an illustration of everything that is wrong with investment banking. You treat investment as a casino rather than a search for value. You make your money off of bets. 

            Try using your skills to find individuals and companies making or doing something useful and steer capital to them. I think that is what investors used to do back in the good old days.

            I don’t need a scapegoat for the financial crisis. A financial crisis is by definition caused by financiers missallocating capital. It was as true in 1929 as in 2008. When finance becomes nothing more than gambling, it leads us to disaster.

          • All entrepreneurship makes money off bets. Making decisions under conditions of uncertainty is very much organic to the human condition. 

            The difference between a casino and a financial market is that if you make the right decisions as an investor, earning a return on your savings is inevitable, while in a casino no matter what you do you are guaranteed to lose money. The only thing they have in common is risk, but the rules of the casino prevent its customers from managing their risk. Financial markets without hedging thus have more in common to a casino than modern finance. 

            What makes you think that I don’t use my skills to find companies making or doing something useful? Let me ask you this: if the risk involved in steering capital to good companies were reduced would that not attract more capital to get steered?

            Would you deny the ability to manage financial risk? Should investors’ only option be a checking account that pays nothing or mutual funds subject to such wild swings people are reluctant to put their money there? Where is the incentive to save money? Wouldn’t saving money be a fools choice between losing money to inflation or losing money to market fluctuations? Wouldn’t the ability to get an attractive rate of return without the wild swings of the stock market steer more capital into worthy enterprises?

            That seems to be a little bit circular an assertion of yours that “a financial crisis is by definition caused by financiers missallocating capital. Why attribute agency to the financiers? Is hyperinflation by definition caused by retailers raising prices? Is a flu epidemic by definition caused by sick people? Why blame financiers when there is empirical evidence asset bubbles are caused by monetary policy. It’s as if you want to blame a banker regardless of the facts simply because it feels good … OK we did do the liquidity but he’s an evil banker!

            Scapegoats are people who get blamed for something that they did not cause. There are more more climatologist that deny global warming than economists that deny asset class bubbles are caused by monetary policy. Why flee from established social science, blaming everything on Shylock?

          • All entrepreneurship makes money off bets. Making decisions under conditions of uncertainty is very much organic to the human condition. 

            The difference between a casino and a financial market is that if you make the right decisions as an investor, earning a return on your savings is inevitable, while in a casino no matter what you do you are guaranteed to lose money. The only thing they have in common is risk, but the rules of the casino prevent its customers from managing their risk. Financial markets without hedging thus have more in common to a casino than modern finance. 

            What makes you think that I don’t use my skills to find companies making or doing something useful? Let me ask you this: if the risk involved in steering capital to good companies were reduced would that not attract more capital to get steered?

            Would you deny the ability to manage financial risk? Should investors’ only option be a checking account that pays nothing or mutual funds subject to such wild swings people are reluctant to put their money there? Where is the incentive to save money? Wouldn’t saving money be a fools choice between losing money to inflation or losing money to market fluctuations? Wouldn’t the ability to get an attractive rate of return without the wild swings of the stock market steer more capital into worthy enterprises?

            That seems to be a little bit circular an assertion of yours that “a financial crisis is by definition caused by financiers missallocating capital. Why attribute agency to the financiers? Is hyperinflation by definition caused by retailers raising prices? Is a flu epidemic by definition caused by sick people? Why blame financiers when there is empirical evidence asset bubbles are caused by monetary policy. It’s as if you want to blame a banker regardless of the facts simply because it feels good … OK we did do the liquidity but he’s an evil banker!

            Scapegoats are people who get blamed for something that they did not cause. There are more more climatologist that deny global warming than economists that deny asset class bubbles are caused by monetary policy. Why flee from established social science, blaming everything on Shylock?

          • valley person

            I posted something earlier that did not show up. I’ll summarize here.

            I answered your questions numerous times. You just don’t like the answer. Fair enough, but I see no point in further repetition.

            Your own description of your investment game, basically gambling on the position of others, better illustrates my point yet than I was capable of doing.  Wasn’t there a time Eric, when investors focused their talents on finding undervalued or up and coming businesses to help capitalize and then gain returns, primarily dividends, later stock sales on? And didn’t that time coincide with the sustained and widely shared rise in American productivity and our economy?

            At what point did the financial world become a legal casino? Was it Carter’s initial bank deregulations? Was it Reagan’s? Was it the invention of securitization? Was it Clinton’s failure to heed Brooksly Born, and to side with Greenspan and Rubin? Was it the replacement of Volker with Greenspan? Was it Bush’s tax cuts and wars, which had to be covered by keeping interest rates too low for too long? Was it all of the above?

            Doesn’t matter. You have just put your finger on the problem. Your “industry” is destroying our nation by having turned finance into nothing more than a chase for short term profits on anything and everything except that which is actually productive and necessary. You want the cause of our collapse, look in the mirror dude.

          • You answered my questions numerous times? Do you mean you answered a couple of my questions numberous times?

            Why don’t I use this opportunity to address some key points I made repeatedly that you ignored every time. Perhaps you can respond to them here. The folks that read these posts have been waiting. 

            1) You never responded to the fact Glass Steagall made our investment banks more risky limiting them to the repo market and barring them from the discount window. 

            2) You never responded to my comparison of Wells Fargo, US Bank, Keycorp, and JPMorgan that tried to opt out of TARP funds and had major inventories of CDOs on their balance sheets. The small, regional banks and credit unions have been failing by the hundreds and continue to do so despite their TARP money, but they lacked access to the CDO market. They were forced to lend the old fashioned way. Why are the banks that are up to their necks in derivatives safer than old fashioned banks?

            3) Why have the CDOs not been defaulting as so many people think they do? Has a super senior tranche ever defaulted? Why are even the equity tranches no worse than high yield corporate bonds?

            4) Subprime mortgages were rare as late as 2004. Countrywide had a nitch business similar to payday lender chains. The subprime market took off when the GSEs were mandated to enter this market and they quickly dominated it. Does this not demonstrate the power of being authorized to cosign the full faith and credit of the US taxpayer onto a loan of any quality and then turn it into a Treasury in the eyes of an investor? Could there possible be a more material cause of the crisis than this fateful 2004 policy change?

            5) Why did the countries without GSEs and with sound monetary policies not have this bubble while the countries that did have GSEs with loose monetary policies had one along with us?

            6) How would the Fed with its full plate of monetary policy and regulating the discount window be a better bank regulator than the OCC, OTS, FDIC, and the SEC?

            7) Are the consequences of losing an independent Fed to conduct monetary policy worth its foray into bank regulation?

            8) What deregulation is Stiglitz talking about and how exactly would it not having passed prevented our crisis without causing another?

            9) don’t forget to provide evidence that the Born proposal would not cause all those disadvantages and provide evidence that it would actually prevent the financial crisis compared to simply not having GSEs and Fed induced excess liquidity. 

          • You answered my questions numerous times? Do you mean you answered a couple of my questions numberous times?

            Why don’t I use this opportunity to address some key points I made repeatedly that you ignored every time. Perhaps you can respond to them here. The folks that read these posts have been waiting. 

            1) You never responded to the fact Glass Steagall made our investment banks more risky limiting them to the repo market and barring them from the discount window. 

            2) You never responded to my comparison of Wells Fargo, US Bank, Keycorp, and JPMorgan that tried to opt out of TARP funds and had major inventories of CDOs on their balance sheets. The small, regional banks and credit unions have been failing by the hundreds and continue to do so despite their TARP money, but they lacked access to the CDO market. They were forced to lend the old fashioned way. Why are the banks that are up to their necks in derivatives safer than old fashioned banks?

            3) Why have the CDOs not been defaulting as so many people think they do? Has a super senior tranche ever defaulted? Why are even the equity tranches no worse than high yield corporate bonds?

            4) Subprime mortgages were rare as late as 2004. Countrywide had a nitch business similar to payday lender chains. The subprime market took off when the GSEs were mandated to enter this market and they quickly dominated it. Does this not demonstrate the power of being authorized to cosign the full faith and credit of the US taxpayer onto a loan of any quality and then turn it into a Treasury in the eyes of an investor? Could there possible be a more material cause of the crisis than this fateful 2004 policy change?

            5) Why did the countries without GSEs and with sound monetary policies not have this bubble while the countries that did have GSEs with loose monetary policies had one along with us?

            6) How would the Fed with its full plate of monetary policy and regulating the discount window be a better bank regulator than the OCC, OTS, FDIC, and the SEC?

            7) Are the consequences of losing an independent Fed to conduct monetary policy worth its foray into bank regulation?

            8) What deregulation is Stiglitz talking about and how exactly would it not having passed prevented our crisis without causing another?

            9) don’t forget to provide evidence that the Born proposal would not cause all those disadvantages and provide evidence that it would actually prevent the financial crisis compared to simply not having GSEs and Fed induced excess liquidity. 

          • valley person

            People are waiting? What…have they been phoning in? I think its down to just us Eric. Nevertheless….

            1) My response is that if Glass Steagall made investment banks more risky…so what? They had 66 years to design their practices to account for those risks.  And when G-S was repealled, they could have merged or become commercial banks. Those that chose to continue operating as before, and then became over leveraged in lousy mortgage instruments courted disaster and found it, much to their surprise.

            2) Large banks have advantages over small ones. They can borrow cheaper. Besides, small business failure rates in any industry are higher than large business failure rates.

            3) I don’t know. But I’m not sure what your point is anyway. Is it that the garbage mortgage packages were not so bad after all, even after the crash? That the only problem is their lack of liquidity? If that is your point, I answered it. Liquidity matters in finance. Its why investors diversify and hold cash, even at low yields.

            4) Subprimes were “rare” prior to 2004? I guess that depends on your definition of rare. Countrywide, the private sector poster child for  this mess, was issuing subprimes left and right long before 2004. Subprimes steadily increased as a share of mortgages from the mid 90s (5%) to 2000 (13% to 2006 (20%). Packaging these into securities increased from 30% to over 80%.

            Your “material cause” is not the material cause that your own sources identified. But it is the material cause that a libertarian economist would have to pick. The “material cause” they id’d was the creation of new financial instruments that changed the way mortgages were issued, chopped up, bundled, resold and insured AND the lack of a proper regulatory framework AND a failure to act within the regulations that existed. 

            5) I don’t know. Germany is a nation of renters so was probably less exposed. Spain and Ireland (the latter the former poster child for the magic of low corporate tax rates by the way) crashed pretty hard. As did Great Britain.

            6) Greenspan failed to recognize the national housing bubble by his own admission, because he believed the market could not over value a commodity for very long and would self correct. The Fed had the power to demand a margin requirement for housing finance. They could have established a 20% down, anything less requiring mortgage insurance. In other words, they could had stopped or curtailed subprime lending at least temporarily to help gently deflate the bubble. He could also have increased capital requirements n banks and other mortgage originators, both of which would have slowed the forming of the bubble. 

            7) I don’t understand the question. Why would the Fed be any less independent if it used its available powers to act in the public interest?

            8) Ask Stiglitz.

            9) I don’t know if the Born proposal would have had negative consequences, and I don’t know if it would have prevented the financial industry from finding other ways to shoot itself and us in the foot, as they seemed and still seem insistent on doing. We do know what failure to adopt her proposal led to. I doubt that following her advice would have created something worse than the worst financial crisis since the 1930s.

            “The difference between a casino and a financial market is that if you
            make the right decisions as an investor, earning a return on your
            savings is inevitable, while in a casino no matter what you do you are
            guaranteed to lose money.”

            Really? If I make a decision to hold on 20 in blackjack and win, I am guaranteed to lose? I don’t think so Eric. Some casino gambling, like slots, is pure chance and the odds are stacked against you. Other casino gambling is skill, and you can improve your odds and walk away ahead.  On the other hand, in your world of finance, if you place your bet with Bernie Madoff, or on Countrywide or Lehman, or other companies highly rated by Wall Street, you can easily walk away with nothing. And the worst part is you were sold a bill of goods on how “safe” your money was. While the Casino makes no such claim.

            “What makes you think that I don’t use my skills to find companies making or doing something useful?”

            I based my comment on the example you gave. You didn’t give any example of doing anything useful. I hope you find occasion to do so.

            “Would you deny the ability to manage financial risk?”

            That’s a silly question. Everyone already has the ability to manage their financial risk. The real question is whether certain financial instruments widely used end up shifting the risk from one or a few companies to the economy at large. The answer in the case of the financial crisis, again according to sources you cited, is yes. That is what happened.

            “Why attribute agency to the financiers?”

            Because they are the ones who allocated the capital, hid and shifted the risks, and brought the house down. I didn’t absolve government by the way. I merely place the primary blame on the financiers. Government failed in multiple ways as well.

            “Why blame financiers when there is empirical evidence asset bubbles are caused by monetary policy.”

            Because a lot of other evidence suggests that monetary policy facilitated, it didn’t CAUSE this particular asset bubble. Monetary policy did not cause lenders to issue countless subprime loans, slice and dice them, resell them, insure them, engage in sloppy record keeping, and so forth. Low short term interest rates led to low long term interest rates, so the “price” of financing a house went down. That in itself is not a bad thing is it? Especially at a time when US manufacturing jobs were being shipped overseas by the millions, so we needed something for blue collar people to do with themselves to earn a decent living. 

            “It’s as if you want to blame a banker regardless of the facts …”

            No Eric. The facts are clear. With due respect, its your ideology and perhaps participation in the finance world that moves you to shift the primary blame to government.

            “Why flee from established social science, blaming everything on Shylock? ”

            Two points. First is that physical science and social science are very different entities. The physical science of global warming is overwhelming. Second the primary cause of the housing bubble and the financial collapse is clearly not established social science. For one thing, the history of it is still too fresh. As evidence, I present your own sources, who identified the same primary causal agents I did.

             

          • 1) Since the crisis among the five stand alone investment banks was peripheral to the financial crisis (despite getting the most attention) this first point could almost be seen as a tangent. But your response reveals an important theme throughout your thinking: “My response is that if Glass Steagall made investment banks more risky…so what?” This is a remarkably cavalier attitude to have about even a limited cause of the crisis. You are hypersensitive about any risk that might have contributed to the crisis, to the point of assuming something unfamiliar to you must necessarily be more risky. Now suddenly when it comes to the unintended consequences of regulatory policy, you become risk averse. 

            “They had 66 years to design their practices to account for those risks.” If this is an attempt to argue that Glass Steagall did not add tremendous risk to our financial system, then you sound like Dick Fuld before the crash, ignoring the fat tail, the black swan event, the improbable outlying outcome, or this is more of that “so what?” disposition toward risk whenever it is caused by regulatory distortion of firm behavior.

            “Those that chose to continue operating as before, and then became over leveraged in lousy mortgage instruments courted disaster and found it, much to their surprise.” If this line of reasoning were used on airlines, it could also be argued that airlines choose to operate in ways that risk shareholder value, but they are path dependent on inefficient processes that were mandated to them by the National Aeronautics Board. After Ted Kennedy sponsored and Carter signed, airline deregulation, the hub and spoke system was mandated by law, even though it was known that a graph-theoretic node system was more efficient. Southwest is able to pay its employees more and charge less than the legacy airlines with its node system. The costs of the legacy airlines changing to a node design are insurmountable. That was more than forty years ago! 

            The Financial Services Modernization Act was less than a decade old. The costs of merging are as significant as restructuring an airline network. The costs of organically building a national commercial bank operation are even more. 

            There was a third option, becoming bank holding companies without having commercial bank operations just to get access to the discount window. This third option was cheaper than the other two, but still very expensive. It required reporting to two agencies simultaneously the SEC and the OCC, promising to cost twice as many lawyers and accountants to maintain compliance with both. The FSMA was a little vague about how to do this, since there is always a danger of compliance confusion in such a regulatory division of labor. In the same way those national flood insurance commercials always warn that flood insurance does not kick in until 30 days after taking out a policy, the ability to access the discount window was not available until a customized framework was set up to spell out which aspect of the bank was accountable to which agency. These costs were seen as unattractive until the black swan event arrived. Bear begged for access to the discount window, and I think it was right for the Fed to make them set up reporting compliance first before giving it to them. Without enough time Bear’s repo market dried up first forcing it to be bought by JPMorgan for $2 a share with the US Treasury indemnifying JPMorgan of losses from Bear’s assets. This merger would not have been possible without the FSMA, and since Bear’s CDOs have not been defaulting, this did not ultimately cost the US Treasury. The way it cost the Treasury money was the way the moral hazard that was created made the other four stand alone investment banks less desperate to find a buyer. John Thain sold Merrill to Bank of America, but Dick Fuld played hard ball with Barclay’s. After penning a deal, Lehman failed before Barclay’s board could vote on the merger. The repo market froze and the Fed decided to declare Morgan and Goldman bank holding companies so they could tap the discount window and figure out the reporting procedures later. At that moment the crisis among American investment banks ended. 

            No doubt their level of leverage was too much for such an event 66 years in the making, but remember we are talking about the amount of leverage relative to their unstable credit source. Deutchebank, UBS, and Handelsbank were all more leveraged had more CDS exposure, but they had nothing to worry about. Wells Fargo, JPMorgan, US Bank and Keycorps had full inventories of CDOs and they tried to opt out of TARP. When dealing with risk, the unintended consequences of regulatory policy is not to be ignored. 

            2) So when I point out that banks involved in the CDO market, with huge inventories of something you like to refer to as crap and garbage have been able to sidestep this crisis to the point of trying to opt out of TARP, but the small regional banks and credit unions managing loan portfolios the old fashioned way desperately needed those TARP funds and are still dropping like flies. You suggest these bigger banks “can borrow cheaper.” If you understood how the price of renting money is set, you would understand how circular that response is. Interest rates are set by three things. The most determinative we talked about before, the supply of money relative to the demand for capital is called the risk free rate. The least determinative is inflation. In the middle is the factor that matters, the risk premium of the borrower. That is to say, the higher the risk the borrowing company will fail the higher their borrowing costs will be. 

            Why are they riskier, because they are small? Your response is “small business failure rates in any industry are higher than large business failure rates.” If we were to take your description of the dangers of the CDO market seriously, the banks that deal in them would be drowning in toxic waste, but apparently the deadly force of the derivatives market pales in comparison to the travails of small business in America. Do you really believe that? Or were you scraping the bottom of the barrel for some response to this stubborn fact that so undermines you entire argument that you have ignored addressing it until now? If it were the case that these smaller banks were simply having business troubles, they would first be laying people off, shutting down branches, and behave like a failing small business. Instead they are being seized by the FDIC for loan losses! 

            These small banks have been failing because they lack the tools to manage their risk as effectively as banks that have access to the derivatives market. If you want to know what our entire banking system would look like if CDOs never existed, take a look at this list: 

            https://www.fdic.gov/bank/individual/failed/banklist.html 

            85 banks have failed this year alone! The CDO market froze for four months. These banks’ assets have been frozen for four years. 

            3) This makes a good segway into the important distinction between liquidity and solvency. I asked you “Why have the CDOs not been defaulting as so many people think they do? Has a super senior tranche ever defaulted? Why are even the equity tranches no worse than high yield corporate bonds?” You started off with a good answer: “I don’t know.” But I cannot imagine the next line is so genuine: “I’m not sure what your point is anyway.” It should not have been hard to gleam my point from our comparison of the fate of large banks with their hedged positions and small banks with their unmanaged risk. A temporary loss of liquidity without default is a small price to pay to avoid a permanent loss of liquidity and suffer default too. I can understand why you have been ignoring this fact and have not made a response until now. 

            So this makes it a little silly of you to ask: “Is it that the garbage mortgage packages were not so bad after all, even after the crash? That the only problem is their lack of liquidity? If that is your point, I answered it. Liquidity matters in finance.” Liquidity matters in finance indeed. If you recognize that, then you should recognize that CDOs are more liquid than their alternative. The CDOs served their function. The CDOs were a part of the solution not a part of the problem. 

            Your next line provides an opportunity to talk about the decisive role that monetary policy played in the crisis. Regarding the importance of liquidity you said: “Its why investors diversify and hold cash, even at low yields.” If you want to know why some risk averse money bought CDOs faster than they could read the prospectuses, then imagine if all the cash equivalent assets have no yield. What if slightly riskier investments have no yield either. But you’re a pension fund, a university endowment, or a charitable foundation. You have to get some yield of some kind to finance your obligations. To get a 4% return you have to take on more risk that you would like but you have little choice. In an environment like this money is sloshing around all over the place searching for yield. This is how artificially low interest rates misprice the cost of risk, create asset class bubbles, and divert capital to things that will go bust. When the Fed begins reversing course, there is a marginal loss of liquidity for all assets, but OTC products more than any other. 

            4) Regarding the movement of the GSEs into subprime, five percent is definitely rare. It is congruent with other alternative lending for consumer finance. Why the 2000-2006 bracket when the action starts in the latter two years of that bracket? Subprime’s rise to 20% of mortgage origination is even more astounding considering the fact that the absolute volume of lending was also much higher. 

            So how did it jump? Before 2004, Countrywide was on its own, and had to watch its underwriting. It had a limited ability to securitize outside of the GSEs, but starting in 2004 they were able to sell to the GSEs instead. As any economist would predict, that is when the underwriting standards dropped, because the due diligence of the ultimate buyers stopped. Before 2004 Countrywide’s counterparties scrutinized its product. After 2004, why bother reading a prospectus when the CDOs have been cosigned by the US taxpayer? This is how the GSEs distort the price of risk. They were able to turn a junk bond into a Treasury. What else was happening in 2004? George W. Bush was running for reelection! This deadly mix of Fed induced liquidity and GSE subsidy blew up before his next term ended. 

            Now this next statement of yours finds me perplexed: “Your ‘material cause’ is not the material cause that your own sources identified.” This is an ironic thing for you to say. Was it not you who misrepresented what Mclean said? I probed a little into your vague summery of her conclusions and it turned out what you called “Wall Street” she was referring to the GSEs. That’s when you made your pivot to “the GSEs ARE the private banking system” argument, which you appear to have dropped. Do I need to just quote from the book for you? 

            5) When I asked you: “Why did the countries without GSEs and with sound monetary policies not have this bubble while the countries that did have GSEs with loose monetary policies had one along with us?” Your response was “I don’t know.” and you mentioned four countries Germany, Spain, Ireland, and the UK – interesting combination. Three of them have GSEs and one does not. Guess which one does not. Will your answer be I don’t know?  
            6) The question was “How would the Fed with its full plate of monetary policy and regulating the discount window be a better bank regulator than the OCC, OTS, FDIC, and the SEC?” You did not answer the question. If there is no evidence that the Fed can do these things better than the existing regulators, why risk its independence? Why risk the development of confusion by blurring the division of labor among agencies?  Again, do you have any evidence that the Fed would do these things better? I will help you out with one of them, because the Fed has been doing it since the beginning. It is a tool of monetary policy: “He could also have increased capital requirements in banks and other mortgage originators” This is called adjusting the required reserve ratio. It affects interest rates by altering the velocity of money. So what you are saying is that the Fed should have raised interest rates, and I agree and have been consistent throughout on this point. Of course the FOMC has more leverage, but hey reserve ratios would have been fine – anything. A 20% down payment rule really means banning the 80/20 loan structure where a second lender loans 20% at a higher rate and has a junior claim to the asset in foreclosure. This is not a call the Fed makes. You are correct in saying that the Fed had the power to do this, but that is because the Federal Reserve Act of 1911 gives the Fed the power to do anything it wants in monetary and banking policy. It has limited its regulatory role to enforcing the discount window to maintain its independence which of course is point 7 that I will get to next. Before I do, I need to call you out again for mischaracterizing what Greenspan said in that October 2008 testimony. First you said he stated he erred in not curbing irresponsible lending practices. He said nothing of the sort. Now you said “Greenspan failed to recognize the national housing bubble by his own admission.” If you have never watched his exchange with Henry Waxman perhaps you ought to watch it. Greenspan states that he thought bank CEOs would take more care not to risk their shareholder’s equity, particularly regarding the capital cushion for credit default swaps.  7) Now regarding Fed independence, this is very important. After the Second World War, only Germany had an inflation hawk political culture from it Weimar hyperinflation days. In the post war period loose monetary policy was never tightened in most western European countries and to a lesser extent here. The inflation of the 70s brought about what is called the Central Bankers’ Revolution. Monetary policy was made independent so that central banks could have the power to cause a recession to fight inflation. If Congress or the President had direct control over the FOMC, the will to raise interest rates would be as high as the will to engage in any other form of austerity. If the Fed engaged in a direct regulatory role the way the OCC, OTS, and SEC do, it would have to have Congressional oversight. This would be like our wanting to have an independent judiciary, but then giving judges other governing jobs too. 8) Let’s recall that you made an assertion about deregulation, said you agree with Stiglitz, and provided a link. What if you had the wrong link and it went to another site dealing with something else like knitting, and I pointed out that your link does not support your assertion. Would you say “Ask Stiglitz”? Seriously, that link does not support your assertion. He did not even mention any regulation that was overturned and he refused to answer a question the interviewer posed about Glass Steagall. That is the best you can do? 9) Somehow I knew that no evidence would be forthcoming regarding Brooksley Born. The only thing you can do for us is provide a name? Her name floats angelically around  the blogosphere, but is notably absent in the academic literature. She is the fairy derivatives princes that would make everything ok.You said: “I don’t know if the Born proposal would have had negative consequences.” Is this more of that “so what” disposition when it comes to adverse side effects from regulations? Forget about Greenspan and Rubin, does the fact that the two most aggressive banking regulators of the later 20th century, Paul Volker and Arthur Levitt, soundly rejected having a centralized OTC derivatives exchange because it would add more risk to our financial system give you any pause?And what would a thinking person make of this turn of phrase? “We do know what failure to adopt her proposal led to.” Do we? How do we know? You just said you have no evidence regarding negative consequences. Do you have any evidence that it would solve anything? Beyond four months of liquidity, you have yet to provide any evidence that derivative themselves have been a disadvantage. I am going to give you an opportunity to defend your one and only piece of supporting material to the capital letter argument. Right now it’s only got a person’s name. Indeed why don’t I bring forward all the arguments you dropped from that post too?10) Any attempt to put an OTC product on an exchange will create the illusion of liquidity. If you recall, this was the only problem we had with CDOs. The Commodity Futures Exchange trades commodities. Every soybean futures contract is identical. Every CDO is unique. Most holders of CDOs in 2008 expected a freeze and were prepared. Had CDOs traded on an exchange, less CDO holders would have been prepared for a freeze. I would think this would be a very big concern for you, after all after learning that CDO did not default during the crisis and have not been defaulting now, you have really been pounding the table on the importance of liquidity.11) The costs were and remain so prohibitive to trade OTC products in this way that it would make the CDO market impossible. Our financial crisis would have been far worse WITHOUT a CDO market than with the one we had. All our banks would look like the hundreds of small, regional institutions that continue to fail to this day despite getting TARP money. That is to say, our banking system would have looked like Sweden in 1991.12) There is a derivative you probably never heard of called a hybrid. It too would be made cost prohibitive to trade on an exchange. The reason you have never heard of it is because it is less used in housing related finance, but provides an essential risk management tool for companies every day. There are many more OTC products you have never heard of but the unintended consequences of making them cost prohibitive are nontrivial.13) Since Born had worked out few of the legal details, there was serous concern that the very act of setting up a regulatory body with its actual rules yet to be determined would cause a run on the existing OTC market. Economists call this “regime uncertainty.”14) Regarding evidence that the Born proposal would even work, let’s phrase it in the form of the big question. With the GSEs distorting the price of risk in mortgage loan origination, and given that the Federal Reserve was systematically distorting the price of risk in the macroeconomy, do you have any evidence to persuade us that trading derivatives on a CFTC regulated exchange would have prevented the emergence of this asset class bubble in the first place? 15) Would it at least have prevented the failure of AIG? or would it just have taken AIG’s business and given us new GSE in return? That is basically what its central exchange would amount to, a quasi government / private financial institution needing its own capital requirements. If its managers miscalculate on the scale that Fannie Mae did, who picks up the tab? What have you solved then?16) Regarding the difference between a casino and financial markets, yes really. if you make the right decisions as an investor, earning a return on your savings is inevitable, while in a casino no matter what you do you are guaranteed to lose money. The distribution in cards for a game of blackjack is a random walk. The probability of winning when you have a winning hand is less important than the probability you will even get a winning hand. The same is true of an investment. The difference is in the probability. Financial markets provide you with better odds. It is a red herring argument to compare a single undiversified losing investment to a single winning hand of black jack. Let’s compare the casino to the stock market in a real way. 

            Let’s take this easy example. Two young men at the age of 18 in the year 1929 are given $100,000. Both want to make their living off the money by investing it. One decides to invest in the SP500, a new index created three years ago. His brother says “your crazy man, the market is way too overvalued. I’m going to play a game of blackjack everyday and live off my earnings!” The investor puts his money in the market on October 23rd of that year. Who will go broke first? What would each of their inheritances be worth in 2009?

            17) That market neutral trade was not all I do, but it is easy to understand how “useful” it is. I put useful in quotation marks because we seem to be standing upon normative ground here. Utility is subjective. It is useful for my partners because I protect their savings from loss. It is useful to the person on the other side of the trade who had his own reasons for voluntarily trading with me. 

            Your attempt to separate the useful trade from the unuseful seems to imply that money goes directly to finance a worthy enterprise. OK I get that, but what about enabling the funding of an enterprise, trades that don’t directly fund an enterprise but by making the trade it allows enterprises to attract more funding? Would that make it useful? Do you see that enabling function in any of the market neutral trades I mentioned?

            18) Let’s look at that silly question about denying the ability to manage risk. You said “Everyone already has the ability to manage their financial risk.” Does the janitor in Singapore not have MORE ability to manage his financial risk? He has the ability to get a safe 8% return with peace of mind. It is against the law for most Americans to invest the way he can. One can only have one’s assets professionally hedged if one is what the SEC defines as an “Accredited Investor” which is the laws way of saying he is already rich. Everybody else is limited to Investment Company Act of 1940 product that almost pay more in fees than returns. 

            Many trades involve the voluntary transfer of risk. One person agrees to pay another person to assume risk. Is this wrong?

            When you talk about imposing risk on the economy, Mclean did indeed show how the GSEs imposed risk on our economy. That is about it. You first paraphrased her as talking about what “Wall Street” did, then we found it was the GSEs prompting you to pivot to the claim that GSEs are representative of private banking. You implied she said Wall Street caused the bubble, turned out oops you meant the Fed. And just again in the last post you claimed that Mclean does not say that the GSEs caused the bubble, requiring me to break out the kindle and find the passages where she did. This is why one ought not to commit the logical fallacy appeal to authority. 

            You have developed a remarkably bad habit of misrepresenting sources. As I think about it, have you not been found to misrepresent all but one source so far? You tell us how Gillian Tett told Terry Gross about how crappy CDOs are turns out she was talking about liquidity, forcing you to save face by maintaining that not being able to sell an OTC  product for a while was the end of the world. You gave us a link to an interview of Joseph Stiglitz as evidence for your position on deregulation, but it turns out he does not even mention a law that was overturned. Alan Greenspan told Henry Waxman that he misjudged the ability of bank CEOs to consider their shareholders when taking risks, particularly credit default swaps, but in the previous post you said he admitted to failing to regulate lending standards and in the last post that he failed to recognize the bubble by his own admission. None of these are true.

            But you got Krugman correct I assume. It sounds like him to imply that it would be wrong for an orphan whose parents died on the Titanic to collect on a life insurance settlement. 

            Of course your claims that CDOs transfer risk onto the economy have been addressed in other places. Do any of the trades that I mentioned in that market neutral position transfer risk onto the economy?

            19) On attributing agency to financiers, let’s apply this to one of the other examples. Do you apply agency to the retailer for inflation? Would you say yes because he is the one who marketed the product, took the customer’s money, and he tried to pass his costs on? 

            Regarding the financier, aren’t they the ones whose job it is to react to price signals? What if someone distorts the price of risk? Do you not transfer agency to the distorter of the price of risk? 

            Who hid risks? Did they bring down the house? Let’s phrase this in the big question: given that the GSEs were distorting the price of risk and the Fed was inducing liquidity on the economy how can you say financiers brought down the house?

             

          • valley person

            “or this is more of that “so what?” disposition toward risk whenever it is caused by regulatory distortion of firm behavior.”

            We live in a world with a lot of regulations, from pollution controls to all sorts of tax subsidies. If you want to spend your life blaming regulations for every market failure, you will be very busy. No one put a gun to the head of the financial industry and forced them to do what they did. No one. For that matter, no one put a gun to the heads of millions of subprime borrowers. Markets have a tendency to overreach. Sometimes spectacularly so. Blaming it on regulatory distortion is like my kid blaming me for him failing math class because  I only forced him to to 1 hour of homework a night.

            “The Financial Services Modernization Act was less than a decade old. ”

            Yes, and Glass-Steagall was around for 66 years prior. That means that if your thesis is true, investment banks should have failed decades earlier.

            “The costs of organically building a national commercial bank operation are even more. ”

            With the resources at their disposal, they could have bought an entire banking network. They wouldn’t have to have built one. Fact is they were in the business they wanted to be in. They were all grown ups. THey made their choices.

            “No doubt their level of leverage was too much for such an event 66 years in the making”

            Please Eric. 66 years in the making? You can’t be serious. The housing bubble started around 2000. Why not trace their bad decisions back the Magna Carta?

            “with huge inventories of something you like to refer to as crap…”

            Make that I and every one of the sources you provided. What they had was a pile of crap. Subprime loans repackaged and disguised to look like a risk free product.

            “You suggest these bigger banks “can borrow cheaper.”

            I should have said they both borrow cheaper and pay cheaper. They gain at both ends.

            ” If you recognize that, then you should recognize that CDOs are more liquid than their alternative.”

            Only until they aren’t. When you chop up subprime mortgages and hide the risk you end up with a bunch of stuff no one can place a value on, and that becomes illiquid. A conventional mortgage may be inherently not very liquid, but its value is known.

            “This is how artificially low interest rates misprice the cost of risk,
            create asset class bubbles, and divert capital to things that will go
            bust.”

            So what is “artificially low?” Since the Fed is charged with keeping inflation in check AND the economy at full employment, whatever interest rate they set is supposed to balance these objectives. Inflation was low, wages were stagnant, employment was below full, so the Fed set what it thought was a necessary rate for short term interest.

            Investors rushed through one particular door, housing, which led to more investors rushing in, which led to lenders lowering standards, which led to buyers rushing in snapping up time bomb mortgages all premised on the next fool rushing in. If low interest rates were all that mattered, the bubble would have happened in the 1950s, when mortgage rates were equally low for a long time. Something else was happening here. And the people you cite say it was the evolution away from standard mortgages to subprimes, the packaging of those subprimes, the phony insurances, the phony AAA ratings, and the rest.

            “but starting in 2004 they were able to sell to the GSEs instead.”

            An event they and other lenders lobbied quite heavily for. They apparently had saturated the market of fools willing and able to play their game. So very late in the bubble, Fannie and Freddie joined in.  Hard to see then, how they were primary causal agents.

            “Was it not you who misrepresented what Mclean said? ”

            No. I believe that was you, in suggesting that she agreed with your position that the GSEs were the primary cause, when she only said they were a contributing cause. 

            “I probed a little into your vague summery of her conclusions and it
            turned out what you called “Wall Street” she was referring to the GSEs. ”

            No. Not in the interview I watched. She was not referring to GSEs. She was talking about the investment vehicles we have been going on about. Subprimes, securitizing, insuring, etc. She did talk about GSEs, but in the same context I’m talking about. Contributing factors, not primary causes.

            “Somehow I knew that no evidence would be forthcoming regarding Brooksley
            Born. The only thing you can do for us is provide a name? ”

            I wasn’t aware I had to provide a dissertation on her. I assumed you knew her story, and it appears you did.

            “Is this more of that “so what” disposition when it comes to adverse side effects from regulations?”

            No Eric, its a simple statement of fact. I can’t know a counter-factual and neither can you. It may be that had her advice been taken, regulatory oversight would have noticed the problem before it became irreversible. It may have had other adverse consequences.

            “if you make the right decisions as an investor, earning a return on your savings is inevitable”

            That is a tautology.

            “while in a casino no matter what you do you are guaranteed to lose money. ”

            No. You may have the odds against you. You are not guarenteed to lose. If that were the case no one would gamble. But a key difference here is that in a casino you gamble with your own money. In finance you gamble with other people’s money.

            “OK I get that, but what about enabling the funding of an enterprise,
            trades that don’t directly fund an enterprise but by making the trade it
            allows enterprises to attract more funding? ”

            If you bet against a loss and win, how does that accomplish anything of utility beyond lining your pocket? How does that enable any enterprise to attract more capital?

            “Many trades involve the voluntary transfer of risk. One person agrees to pay another person to assume risk. Is this wrong?”

            No Eric. I’m sure that every individual (legal) action taken by your world has a justification somewhere. Every new financial instrument made perfect sense. It was the cumulative effect of all those instruments applied to a bubble that broke the economy. The transfer of risk was based on what turned out to be phantom equity that could not pay off once the risk became a route. So the risk was shoved off onto society as a whole, either in the form of a bailout or in the form of an economic meltdown. Either way we go bankrupt and you get to walk away with a nice parachute. You left the rest of us with a Hobsen’s choice.

            “You implied she said Wall Street caused the bubble, turned out oops you meant the Fed.”

            I didn’t imply it. I said it. And no, I did not mean the Fed and neither did she. Her thesis was that there were a number of contributing elements that taken together resulted in a bubble and a meltdown. She included low interest rates (Fed) and housing policy, but was quite clear that the new financial instruments and questionable behavior by the financial industry were primary contributors.

            Sure, if interest rates had been kept artificially high, fewer people would have been able to buy homes, fewer bad mortgages would have been issued, private finance would have found some other useless commodity to inflate, like gold (oops) and we wouldn’t be having this discussion. But all lower interest rates did was make mortgages more affordable for more people. Turning that good thing into a casino was the doing of your industry.

            “You have developed a remarkably bad habit of misrepresenting sources.”

            No, but you have a remarkably annoying way of twisting what I say into what you want me to have said so you can argue with that. Your sources said what I said they said. They drew different conclusions than you do. 

            “Alan Greenspan told Henry Waxman…”

            And do you think that was the only thing Greenspan had to say about the entire mess? He said on a number of occasions that he failed to recognize the bubble, believed the free market woud take care of things, and thus failed to take action. He did not enumerate specific actions he could or should have taken, and in some interviews has equivocated on this point. My suggestion on what he could have done was taken from the Economist, not from the Maestro.

            In his testimony to Waxman, “he said he had made a
            “mistake” in believing that banks, operating in their own self-interest,
            would do what was necessary to protect their shareholders and
            institutions. Greenspan called that “a flaw in the model … that
            defines how the world works.”

            He acknowledged that he had also been wrong in rejecting fears that
            the five-year housing boom was turning into an unsustainable speculative
            bubble that could harm the economy when it burst. Greenspan maintained
            during that period that home prices were unlikely to post a significant
            decline nationally because housing was a local market.”

            https://www.msnbc.msn.com/id/27335454/ns/business-stocks_and_economy/t/greenspan-admits-mistake-helped-crisis/

            I ask you Eric, does that say he did or did not say he missed the speculative bubble for what it was? I mean…you think I made this up? Please.

            “But you got Krugman correct I assume. It sounds like him to imply
            that it would be wrong for an orphan whose parents died on the Titanic
            to collect on a life insurance settlement. ”

            What I presume he meant was that the parents would have been unable to pay off, being dead and all. But this illustrates why I can’t seem to break through to you. You may be a literalist.

            “Regarding the financier, aren’t they the ones whose job it is to react to price signals?”

            Is that it? That is their entire job? That absolves them of peddeling crappy products, wrapping them in packages no one could understand, falsifying their risk, and covering their bad bets with other people’s money with bets against their own clients? Are there no ethics in this crowd?

            “given that the GSEs were distorting the price of risk and the Fed was
            inducing liquidity on the economy how can you say financiers brought
            down the house? ”

            I’ve said it every way I know how. McLean said it. Morgensen said it. Greenspan even said it. You can’t accept it because it doesn’t fit your narrative. You think that there is such a thing as an entirely free market with no public policy distortions, or if there isn’t there should be and all will be great. Bank failures losing the deposits of working people? No problema. They should spread their risk to many banks. A nation of renters with no equity? Their own fault. 50 million with no health insurance? Let them pay with chickens.

             

          • 1)  To say that there are a lot of regulations
            out there does not lessen the need to analyze their effects. It increases the
            need. The US banking system being the most heavily regulated financial sector
            in the world has more such need than its safer global peers. Regulators in
            Sweden are able to focus like a laser on fraud and are not distracted by
            monumental decisions like whether or not to separate entire sections of banks
            and intentionally limit their line of credit. So your answer to why you are so
            carefree about risk induced by regulations is that it is hard to do so? Does it
            then follow that you have an utter risk aversion to any financial instrument
            you find complex because it is easy to do so? One need not follow pollution
            controls to see that the only investment banks that failed in 2008 had less
            exposure to CDOs and were less leveraged than their global peers.

             

            “No one put a gun to the head of the financial industry and forced them
            to do what they did.” The coercive power of the state forced the separation of
            investment banking and commercial banking creating the repo market and
            excluding them from the discount window. For your example of your son failing
            his homework to be analogous, this would be a case where for most of his life
            he has only needed to study thirty minutes, but you FORCE him to limit his
            studies to one hour. Eventually a black swan event emerged that required more
            than an hour’s worth of studies. You changed the rules some time ago, but it
            would cost him some of his own money to take advantage of the liberalization,
            so the desire to save money prompted him to take the risk, thus his own greed
            prompted him to continue taking the risk. He bears full responsibility, but
            this still begs a certain question about having counterproductive policies in
            the first place.

             

            “Glass-Steagall was around for 66 years prior. That means that if your
            thesis is true, investment banks should have failed decades earlier.” You seem
            to not get the concept of a low probability event. A run on the repo market was
            predicted for years. I am not aware of any close calls before 1998, but LTCM
            demonstrated it was more than a conjecture catalyzing the repeal of Glass
            Steagal.

             

            “With the resources at their disposal, they could have bought an entire
            banking network. They wouldn’t have to have built one. Fact is they were in the
            business they wanted to be in. They were all grown ups. THey made their
            choices.” Though the first sentence ignores that the costs would be very high,
            I essentially agree. Like I said in the analogy of your son, they bear responsibility;
            this does not remove the fact that the effects of the crisis would have been
            less if our banks were integrated like the rest of the world. There would still
            be a crisis but it would be relegated to owners of junior equity tranches
            losing money and an S+L like small banking crisis that continues to this day.

             

            2) You dropped my point that a banking system without CDOs is a banking
            system like Sweden in 1991 where it all fails together. If all our banks owned
            their loan portfolios the way small banks and credit unions in America do all
            our banks would be failing and taking their TARP loans down with them.

             

            3) When I keep making this
            distinction between liquidity and solvency, there is a possibility that you
            somehow think I am defending the way these OTC products became commodities. I
            realized that when I read the quotes you provided from Morgensen, scratched my
            head and wondered how you possibly thought they supported your argument. I am
            not defending the practice of having GSEs act as intermediaries between
            mortgage originators and investment banks so that the investment bankers can
            sell the CDOs with the illusion that they are just like a Treasury. That is
            certainly analogous to selling spoiled meat.

             

            What I thought I was
            discussing with you on this matter is securitization itself. When I was reading
            Gilian Tett’s reporting in 2005, she convinced me that many super senior
            tranches were going to default. To the best of my knowledge none have. If it
            seems I have a chipper attitude about CDOs, it’s because I was bracing for far
            worse, long before anyone thought there was a problem. Now not many people know
            much about the crisis with many urban legends forming.  Many people don’t know super senior tranches have
            not been defaulting; I cringe when I hear “crap” used to describe a remarkable
            product. There is a tendency for you to describe slicing up mortgages itself as
            a bad thing. Can we agree that the bad thing here was the way moral hazard
            distorted the perception of these products’ risk? They were both bought and
            sold like a commodity when they should have been treated individually. Still
            their low default rates continues to surprise me, demonstrating that if CDOs
            can actually manage the risk of the terrible underwriting of the past decade,
            imagine how well they would perform if they were purchased with more due
            diligence and better underwriting.

             

            “I should have said they both borrow cheaper and pay
            cheaper. They gain at both ends.” Are you talking about wages here? This does
            not address the evidence that small banks are at the mercy of fate regarding
            nonperforming loans.

             

            Regarding liquidity, again
            a loss of four months of liquidity is better than its alternative, which is no
            liquidity topped with no diversification. What makes CDOs liquid at all is
            their diversification. They froze when their diversification came into
            question. The inability to diversify at all has taken down hundreds of small
            banks. They did not need securitization to participate in the bubble, but when
            the bubble collapsed they would have been happy to wait even a half a year or
            even two years to restructure, but they never will. Without securitization this
            is where Sweden’s banking system found itself in 1991.

             

            I am not sure you
            understand the contradiction in this statement of yours “A conventional mortgage may be inherently not very
            liquid, but its value is known.” Price discovery comes from sales, not a
            model that tells a small bank what their portfolio is REALLY worth. Every
            mortgage is unique. The qualitative difference between various CDOs is much
            less than a small bank’s two best borrowers on its books. The spread between
            the risk premium of a CDO and an individual mortgage is huge. Remember all
            credit products share the same risk free rate and inflation expectations, the
            risk premium determines spreads. To compare the risk of the highest quality
            individual mortgage a small bank has to a CDO is the same as comparing the
            equity risk premium of the highest quality company on the SP500 to the index
            itself which is full of lots of not so quality companies. The index has less
            risk than its highest quality component parts, even though the index is full of
            bad companies. When Enron went bankrupt, it was a component of the SP500 but
            represented only 1/500th of an index investor’s loss. Thus the
            opposite of your statement is true; small banks’ assets are far less liquid
            BECAUSE their price is far less knowable. So while it is true that CDOs are
            liquid until they aren’t, that is better than being illiquid and remaining so
            permanently.

             

            This is why there is no
            daylight between my understanding of the CDO market and Gillian Tett’s. Indeed
            since I don’t manage enough assets to participate in this market myself, most
            everything I know about them has been from reading her reporting for years.
            Something did go terribly wrong in the CDO market. They were perceived by investors
            as Treasuries and traded accordingly. It takes a great deal of distortion in
            the price of risk for any OTC product of any kind to experience that
            phenomenon. Most asset class bubbles are in the trading of a more liquid asset
            of some kind.

            “So what is artificially low?” Glad you asked. When
            we enjoy interest rates that reflect a high savings rate economy but our
            households actually have a low savings rate – that is artificially low. Look at
            the savings rate in the 1950s and compare it to this past decade. If you want
            to know why we do this, you identified it when you mentioned the Fed’s dual
            mandate.

             

            I think this is an accurate description of a bubble “Investors rushed
            through one particular door, housing, which led to more investors rushing in,
            which led to lenders lowering standards, which led to buyers rushing in
            snapping up time bomb mortgages all premised on the next fool rushing in.”
            Let’s use your door analogy further to help understand why real estate was a
            bubble recently, but it rarely is. Monetary policy determines what we will go
            through a door, but other factors determine which door we will go through. Some
            doors are more used than others; the more commoditized the asset, the more
            often it will be the source of a bubble. That there will be a bubble is purely
            a monetary phenomenon, but what it is affected by different incentives at the
            time relative to the perishable historical memory of a past bubble. The sky
            rocketing price of the LinkedIn IPO looked too much like the Netscape IPO
            causing downward pressure on tech stocks while the Netscape had the opposite
            effect. We have a historical memory of a tech bubble now that did not exist in
            the 90s. I can say for certain that our current countercyclical monetary policy
            will cause another bubble. I am also confident it will not be real estate. 

          • 4) “An event they and other lenders lobbied quite heavily
            for.” No doubt they lobbied for it too, but no amount of lobbying from
            originators and investment banks could so fundamentally move Congress and HUD
            to not only allow lower lending standard but to go so far as to mandate them
            without the GSEs who controlled the entire political process at every level.
            Nobody can lobby better than a government sponsored enterprise. That is the
            entire thesis of Morgensen’s book. The idea that Countrywide and NovaStar were
            good and the GSEs were evil has never been my position. It is my position that
            Countrywide and NovaStar were able to get away with things they never would
            have been able to do without the GSEs acting as an intermediary.

             

            “They apparently had saturated the market of fools willing and able to
            play their game.” This is exactly correct. Without the ability to cosign
            taxpayers on to their products they got very low prices and had a thin market.  

             

            “So very late in the bubble, Fannie and Freddie joined in.  Hard to
            see then, how they were primary causal agents.” That is not what a five-fold
            increase in less than a decade demonstrates, most of which came after 2004.
            Remember those numbers you gave me were percentages! Look at the spike in
            nominal terms. All loans of all quality were increasing, yet subprime
            dramatically gains market share right at the peak of the bubble at the moment
            the GSEs are able to turn them into Treasuries. This very moment is what
            prompts Mclean to say “the very size of the GSEs’ purchase undoubtedly inflated
            the housing bubble.”

             

            “she only said they were a contributing cause.” I don’t
            see a hedging clause in that sentence of hers. I also did not see that same
            locution attributed to any other factor. I do not dispute that Mclean does not
            pound the table as hard as Morgensen, but I do not need them to commit the
            logical fallacy of appealing to authority. To me it is the following fact that
            Mclean provides that serves as a key premise to support MY conclusion:

             

            “What made Fannie and Freddie indispensable in the new
            mortgage market was one simple fact: the mortgages they guaranteed were
            the only mortgages investors wanted to buy. After all, the GSE guarantee meant
            that the investors no longer had to worry about the risk that homeowners would
            default, because Fannie and Freddie were assuming that risk.”

             

            Regarding your portrayal of this mysterious interview you initially
            introduced it into our conversation by sayings “I have seen an
            interview with Bethany Mclean talking about her book and its findings. She said
            very clearly that the financial instruments Wall street created were the
            primary cause of the crisis. Once banks were able to off load subprime
            mortgages, the game changed and mortgages went from being low risk investments
            to high risk ones. Lenders stopped caring about the ability of the borrower to
            be able to pay for years on end. They even talked borrowers into higher risk
            ARMs who were well qualified for low risk 30 year conventionals because they
            (Washington Mutual in particular) could package the ARMs and re-sell them
            easier. Housing mortgages became a game of flipping to the next fool in the
            line. And record keeping was so sloppy that to this day no one really knows who
            owns what piece of which mortgage, evidenced by the foreclosure fiasco.”

             

            I immediately responded by pointing out the equivocation you are using
            to represent her: “You listen to interviews where people refer to Wall Street,
            forgetting that is merely a term for the financial sector. The GSEs are Wall
            Street. So when you hear someone say “the financial instruments Wall
            Street created caused the financial crisis”, for you to claim that the
            GSEs cosigning the full faith and credit of the US taxpayer was not the
            material cause, you have to make the absurd assumption that had it not been US
            policy to remove the risk from these assets, investors would have behaved the
            same way.”

             

            In your next post you continued your Wall Street means Goldman
            Sachs line. This is when you seem to have crossed the line from vagueness to
            misrepresentation: “The financial instruments were created by the
            investment banks, aka “wall street.” They found ways to securitize
            disparate mortgages and turn these into revenue.” This of course is all true,
            but it begs the question why this is a problem, after all retailers are able to
            sell off their distressed debt to be structured into CDOs with no problem
            because no one ever thought it was a Treasury. If someone buys subprime debt
            with no cosignature of the US taxpayer, they take the time to read each
            prospectus.

             

            My response was brief but to the point: “The only way to get well
            managed banks to underwrite no doc loans, accept no down payment, and the
            relatively rare negative amortization loan that you refer to was to have them
            guaranteed by the GSEs.” You then dropped my response so as to pivot to Siglitz
            who said nothing to support your argument in his interview. After I refuted
            your link and Stiglitz’ credibility you brought Mclean up again: “Steiglitz,
            whom you also dismiss, makes persuasive arguments consistent with what McLean
            concluded.”

             

            At this point I realized that I had to break it down to you piece by
            piece: “When you first mentioned Mclean you said this: ‘I have seen an
            interview with Bethany Mclean talking about her book and its findings. She said
            very clearly that the financial instruments Wall Street created were the
            primary cause of the crisis.’ What instruments? What should have been done to
            said instruments? Who is Wall Street? If we are talking about Fannie Mae
            wouldn’t I agree with this? ‘Once banks were able to off load subprime
            mortgages’ Off load them to whom? The GSEs! How does this support your
            argument?

             

            You then conceded that we were not talking about lower Manhattan, and
            that this included the GSEs, backing out of that earlier claim that Mclean only
            meant investment banks, but you then pivot into this dead end argument: “Fannie
            Mae by the way, was as much a part of the private finance system as were the
            banks. I get a kick out of those who pretend it was a government agency. It
            wasn’t. It was chartered and limited in scope by the government. But it was
            privately held and run.” Talk about coming full circle! Remember my argument is
            that no amount of regulation can prevent a financial crisis if GSEs act as
            intermediaries between mortgage originators and investment banks to turn CDOs
            into Treasuries. In addition to distorting risk perception, GSEs are able to
            lobby government in a way that not only lowers lending standard, but actually
            mandates lower standards. Rather than seek deregulation, the GSEs use
            regulation to their advantage and to the other stakeholders’ advantage too
            against the public good seeking private gains while shifting risk onto the
            public.

             

            Somehow, none of this prevented you from saying things like this over
            and over again: “As evidence, I present your own sources, who identified the
            same primary causal agents I did”

             

            And thus my summery of this is quite accurate: “I probed a little
            into your vague summery of her conclusions and it turned out
            what you called “Wall Street” she was referring to the
            GSEs.” Indeed you even admitted as much, but now we have circled back to
            square one with you response: ‘No. Not in the interview I watched. She was not
            referring to GSEs. She was talking about the investment vehicles we have been
            going on about. Subprimes, securitizing, insuring, etc. She did talk about
            GSEs, but in the same context I’m talking about. Contributing factors, not
            primary causes.”

             

            Who is the primary cause for turning a mortgage into a Treasury bond? Who
            owns Congress? Who stand at the commanding heights of the CDO market? The GSEs!
            How closely were you watching this video? Did she say anything like this? “No
            truly private company can compete effectively with Fannie Mae or Freddie Mac,
            operating under their special charter,” Pope told lawmakers. What he meant, in
            part, was that because of the GSEs’ implicit government guarantee, investors
            were willing to pay a higher price for Fannie- and Freddie-backed securities,
            since the federal government appeared to be standing behind them. For the same
            reason, Fannie and Freddie could borrow money at a lower cost than even mighty
            General Electric, with its triple-A rating.” or this? “Fannie and Freddie had
            the reputation of being “difficult, prickly, and willing to throw their weight
            around at a senior level,” according to one person who had regular dealings
            with them. It didn’t matter. They couldn’t be shut out of the market, because
            they were the market.”

             

            Then there was the way you initially portrayed her description of the
            cause of the bubble, without mentioning she was talking about monetary policy.
            It prompted me to probe you on this, and you replied that yes indeed she was
            talking about monetary policy. Since you are making great logical back flips to
            find evidence that deregulation was the causal force of the crisis, I can
            understand why you would omit that detail to save face, but I cannot understand
            why the discomfort of doing those back flips does not force you to face the
            facts.  

             

            But now I like your response: “She included
            low interest rates (Fed) and housing policy, but was quite clear that the new
            financial instruments and questionable behavior by the financial industry were
            primary contributors.” I couldn’t have said it better, perhaps you are
            facing the facts. You just said monetary policy, the GSEs, and the GSEs’
            stakeholders who originated the mortgages and marketed them for the GSE. Take
            out the Fed induced liquidity and the GSE intermediaries and not much is left
            to inflate a bubble.

             

            5) Regarding the four counterfactual countries, you have again dropped
            this point. The existence of this placebo evidence is not a fact that your
            argument can ignore.

             

            6) You failed to provide any evidence that the Fed would be a better
            consumer finance regulator than the OCC or even state regulators.

             

            7) You failed to address the problem of losing political independence to
            conduct monetary policy.

             

            Regarding Greenspan, there has only been one time he has ever admitted
            to a mistake emerging from his ideology and that was at that hearing. The only way
            he has been talking about his mistake ever since is when he tries to spin what
            he said. He has never admitting to failing to spot the bubble. In that super
            short clip he says they did not forecast the bubble, which is a true statement.
            He said the same thing in 2005 when asked if there was a housing bubble. He
            said the Fed does not forecast housing prices or track bubble formation. It
            only follows inflation. He gets asked this all the time, now after the crisis,
            and he says the same thing, that it is not the FOMC’s job to pop bubbles. So
            from “we don’t forecast such things” to “we did not expect major housing
            problems” needs to be put into the context of their rejection of the Fed as
            bubble popper.

             

            This is what you attributed of Greenspan first: “Greenspan had the
            authority to prevent irresponsible lending practices happening under his nose.
            He stated that he erred in not using this authority because his belief in the
            “free market” told him that banks would not overly risk the capital
            of their investors.”

             

            Then you said this: “Greenspan failed to recognize the national housing
            bubble by his own admission, because he believed the market could not over
            value a commodity for very long and would self correct.”

             

            Now you got it right: “he said he had made a 
            “mistake” in believing that banks, operating in
            their own self-interest,
            would do what was necessary to protect their
            shareholders and 
            institutions. Greenspan called that “a flaw in the
            model … that 
            defines how the world works.”

             

            I don’t think you made the first two up. I think they came from some
            filtered source like that heavily edited MSNBC clip. 

          • 8) If you drop Stiglitz you drop deregulation. Again you said that you
            agree with Stiglitz, that deregulation caused the crisis, then you provided a
            link that did not support your conclusion. It told us neither what deregulation
            caused the crisis, nor how it caused the crisis.

             

            9) You do not have to provide a dissertation on Born, just provide an
            argument. In The Rhetoric, Aristotle suggests that to convince someone of a
            policy change one must establish three stock issues: need, plan, and
            advantages. To establish need, one must clearly define what is to be
            accomplished. To establish plan one must demonstrate an ability to solve for
            the need. And to establish advantages you have to demonstrate that the solvency
            of the plan exceeds any ancillary disadvantages. All you gave was a name. I
            will carry through the 4 disadvantages and 2 problems with her plan to give you
            an opportunity to make an argument.

             

            What’s this? “I can’t know a counter-factual and neither can you. It may
            be that had her advice been taken, regulatory oversight would have noticed the
            problem before it became irreversible. It may have had other adverse
            consequences.” It is easier to look backwards than look forwards. She made a
            proposal and it was soundly rejected for the evidence at the time, but you have
            new evidence she never had. This should be easier not harder. She actually made
            the proposal during a financial crisis – perfect timing for a regulatory
            proposal. It was soundly rejected because it was so obvious that it would have
            made the crisis they were going through worse. Now you can look backwards. You
            have more to work with than she did. “It may have had other adverse
            consequences” indeed.

             

            10) Any attempt to put an OTC product on an exchange will create
            the illusion of liquidity. If you recall, this was the only problem we had with
            CDOs. The Commodity Futures Exchange trades commodities. Every soybean futures
            contract is identical. Every CDO is unique. Most holders of CDOs in 2008
            expected a freeze and were prepared. Had CDOs traded on an exchange, less CDO
            holders would have been prepared for a freeze. I would think this would be a
            very big concern for you, after all after learning that CDO did not default
            during the crisis and have not been defaulting now, you have really been
            pounding the table on the importance of liquidity.

             

            11) The costs were and remain so prohibitive to trade OTC
            products in this way that it would make the CDO market impossible. Our
            financial crisis would have been far worse WITHOUT a CDO market than with the
            one we had. All our banks would look like the hundreds of small, regional
            institutions that continue to fail to this day despite getting TARP money. That
            is to say, our banking system would have looked like Sweden in 1991.

             

            12) There is a derivative you probably never heard of called a
            hybrid. It too would be made cost prohibitive to trade on an exchange. The
            reason you have never heard of it is because it is less used in housing related
            finance, but provides an essential risk management tool for companies every
            day. There are many more OTC products you have never heard of but the
            unintended consequences of making them cost prohibitive are nontrivial.

             

            13) Since Born had worked out few of the legal details, there was
            serious concern that the very act of setting up a regulatory body with its
            actual rules yet to be determined would cause a run on the existing
            OTC market. Economists call this “regime uncertainty.”

             

            14) Regarding evidence that the Born proposal would even work,
            let’s phrase it in the form of the big question. With the GSEs distorting
            the price of risk in mortgage loan origination, and given that the Federal
            Reserve was systematically distorting the price of risk in the
            macroeconomy, do you have any evidence to persuade us that
            trading derivatives on a CFTC regulated exchange would have prevented
            the emergence of this asset class bubble in the first place? 

             

            15) Would it at least have prevented the failure of AIG? or would it
            just have taken AIG’s business and given us new GSE in return? That is
            basically what its central exchange would amount to, a quasi government /
            private financial institution needing its own capital requirements. If its
            managers miscalculate on the scale that Fannie Mae did, who picks up the tab?
            What have you solved then?

             

            16) If you make the right decisions as an investor, earning a
            return on your savings is inevitable is not a tautology it is a truism. A
            tautology would be this: an investor is someone who invests his money. It is a
            truism because the assumption that right decisions will be made is an easy
            assumption to make. Let’s make the same statement about gambling in a casino:
            if you make the right decisions as a casino gambler, earning a return on your
            savings is inevitable. The only way we could make this statement true is if he
            makes the decision not to gamble, but doing nothing provides no guarantee that
            there will be a return on his savings.

             

            Then you say “No. You may have the odds against you. You are not guaranteed
            to lose.” I am not sure you really believe that. The reason I question your
            sincerity is that it was probably no accident that you failed to tell me which
            brother would go broke first.

             

            17) You asked: “If you bet against a loss and win, how does that accomplish
            anything of utility beyond lining your pocket? How does that enable any
            enterprise to attract more capital?” I’m glad you asked. Let’s cover the two
            most basic forms of bearish trades, the short and the put. Shorting a stock
            means that you rent the shares from an owner who will charge you interest. You
            sell the shares first and close the position by buying them later and giving
            them back to the lender. It has three utilities. First, it puts downward
            pressure on bubbles. Second it prevents a market from freezing when everyone
            wants to sell. Short sellers buy a stock as its falling to cover their
            position. Sometimes they are the only ones buying. Third, it puts a floor on
            how far the stock can drop, because once the shorts start covering their
            positions they knock the price back up. All of these things add up to increased
            liquidity. This is a good thing just like you said “liquidity is everything in
            finance.” If you want more people to participate in IPOs, make the market for
            their equity as liquid as possible.

             

            The put is an option contract. If you buy a put, you are buying the right
            to be compensated if a stock drops below an agreed upon price. The buyer pays a
            premium for a six month contract. Does that sound familiar? Your auto insurance
            is a put. You are transferring risk to another party that voluntarily agrees to
            take it. You are hedging. Options contracts are insurance products for stocks. Auto
            insurance is an OTC derivative. Put contracts are insurance for stocks.

             

            18) In response to the following question: “Many trades involve the
            voluntary transfer of risk. One person agrees to pay another person to assume
            risk. Is this wrong?” You responded with this:

             

            “No Eric. I’m sure that every individual (legal) action taken by your
            world has a justification somewhere. Every new financial instrument made
            perfect sense. It was the cumulative effect of all those instruments applied to
            a bubble that broke the economy. The transfer of risk was based on what turned
            out to be phantom equity that could not pay off once the risk became a route.
            So the risk was shoved off onto society as a whole, either in the form of a
            bailout or in the form of an economic meltdown. Either way we go bankrupt and
            you get to walk away with a nice parachute. You left the rest of us with a
            Hobsen’s choice.” You seem to have missed a key word in my question “voluntary.”
            When the GSEs cosigned the risk of the mortgage market onto the public, this
            was the coercive power of the state, a very different thing from two willing
            parties entering into a put contract.

             

            19) When it comes to monetary policy you bounce every which
            way. You go from an extreme skepticism that economics is even a science, not
            even rising to the overdeturmined complexity of climate research to then
            shifting to greater factual certainty like this: “Sure, if
            interest rates had been kept artificially high, fewer people would have been
            able to buy homes, fewer bad mortgages would have been issued, private finance
            would have found some other useless commodity to inflate, like gold (oops) and
            we wouldn’t be having this discussion.”

             

            Let’s break this sucker down. You might be on to something! If interest
            rates were higher we would not be having this discussion indeed. I would only
            trifle with your notion of “artificial.” If we simply kept the growth of the
            money supply proportional to GDP growth, then interest rates would be higher
            given our low savings rate. That’s how it’s done in Switzerland. I recall you
            and I agreeing we should have a Swiss style healthcare system. Can we agree on
            Swiss monetary policy?

             

            Regarding the reaction to price signals you respond: “Is that it? That
            is their entire job? That absolves them of peddeling crappy products, wrapping
            them in packages no one could understand, falsifying their risk, and covering
            their bad bets with other people’s money with bets against their own clients?
            Are there no ethics in this crowd?”

             

            In your run down of the causal effects of monetary policy, you sort of
            answered this for me. Yes that’s it. The pension funds desperate for a decent
            rate of return easily bought into the idea that an equity tranche CDO was a
            high yield Treasury. They bought them faster than they could read the prospectuses.
            Let interest rates rise to their natural level and investors don’t touch these
            CDOs with a ten foot pole without substantial compensation, because they will
            have better options. If you raise the price of risk all endogenous financial
            crisis go away. I want an economy with a natural interest rate and without
            GSEs, but I don’t judge the people working at Fannie Mae as unethical. Every
            human being is greedy and prices matter. We cannot change human nature, but we can
            avoid some of its worst outcomes if we stop distorting the price of risk.

             

            Then there was your conclusion:
            “I’ve said it every way I know how. McLean said
            it. Morgensen said it. Greenspan even said it. You can’t accept it because it
            doesn’t fit your narrative.” Not one of those people has identified a
            regulation that can compensate for the market distorting effects of the GSEs.

             

            “You think that there is such a thing as an entirely free market with no
            public policy distortions, or if there isn’t there should be and all will be
            great.” I have pointed out to you several occasions that most of the worlds’
            banking sectors are far less regulated than ours is. I identified countries
            with sound monetary policies that avoid financial crisis. This is not my imagination. It seems to be you that imagine these counterfactual placebos don’t exist. 

          • Nocera, Joe; McLean, Bethany. All the Devils Are Here: The Hidden History of the Financial Crisis. Penguin Group. Kindle Edition.

            “What made Fannie and Freddie indispensable in the new mortgage market was one simple fact: the mortgages they guaranteed were the only mortgages investors wanted to buy. After all, the GSE guarantee meant that the investors no longer had to worry about the risk that homeowners would default, because Fannie and Freddie were assuming that risk. For some investors, GSE-backed paper was the only type of mortgage they were even allowed to buy. In many states, it was against the law for pension funds to purchase “private” mortgage-backed securities. But it was perfectly okay for them to buy mortgage securities backed by the GSEs, because those were treated like obligations from the government. States, meanwhile, had blue sky laws designed to prevent investment fraud, meaning that Wall Street firms had to register with each of the fifty states to sell mortgage-backed deals, a process they had to repeat on every single deal. Mortgage-backed securities issued by the GSEs were exempt from blue sky laws. In 1977, in one of the earliest efforts to put together a mortgage-backed securities deal, Salomon Brothers developed a bond made up of Bank of America mortgages. It was a bust. After that, almost all the early deals were ones in which Fannie and Freddie were the actual issuers of the mortgage-backed securities, while Wall Street was essentially the marketer.” (Kindle Locations 410-419)

            “Fannie and Freddie had the reputation of being “difficult, prickly, and willing to throw their weight around at a senior level,” according to one person who had regular dealings with them. It didn’t matter. They couldn’t be shut out of the market, because they were the market. The government agencies had issued almost $230 billion in mortgage-backed securities, while the purely private sector had issued only $10 billion. That same year, Larry Fink and First Boston pioneered very first so-called collateralized mortgage obligation, or CMO, a mortgage-backed security with three radically different tranches: one with short-term five-year debt, a second with medium-term twelve-year debt, and a third with long-term thirty-year debt. (Fink still keeps on his desk a memento from the deal; it has a tricycle to memorialize the three tranches.) But as usual, the actual issuer of the mortgages wasn’t First Boston. It was Freddie Mac. “They [the GSEs] were the enabler,” Ranieri would later explain. “They wound up having to be the point of the spear.” The fees from these deals were plentiful, to be sure. The sheer excitement of building this new market was exhilarating. But there was something about being subservient to the GSEs—with all the built-in advantages that came with their quasi-government status—that stuck in Ranieri’s craw.” (Kindle Locations 420-429)

            “No truly private company can compete effectively with Fannie Mae or Freddie Mac, operating under their special charter,” Pope told lawmakers. What he meant, in part, was that because of the GSEs’ implicit government guarantee, investors were willing to pay a higher price for Fannie- and Freddie-backed securities, since the federal government appeared to be standing behind them. For the same reason, Fannie and Freddie could borrow money at a lower cost than even mighty General Electric, with its triple-A rating.” (Kindle Locations 449-453)”In the end, though, it didn’t really matter whether Fannie and Freddie moved into riskier mortgages quickly or slowly, reluctantly or gleefully. What mattered was that they entered this new market at all. In so doing, they gave their imprimatur to what had previously been an entirely separate universe. A line that had once been absolute was now blurring. “The whole definition of subprime was ‘the stuff that Fannie and Freddie wouldn’t touch,’” a former executive explains. No longer. (Kindle Locations 1125-1130)”When the housing goals became harder to fulfill, the triple-A tranches provided an easy way to meet their mission numbers. Eventually, the Street began designing a special GSE tranche that was packed with loans that satisfied the affordable housing requirements. And HUD allowed the GSEs to count these purchases toward their goals. Over time, Fannie and Freddie became two of the world’s largest purchasers of triple-A tranches. In the peak year of 2004, the GSEs bought about $175 billion in triple-As, or 44 percent of the market. While there were plenty of buyers for triple-A-rated securities, the very size of the GSEs’ purchase undoubtedly inflated the housing bubble.” (Kindle Locations 3571-3579)The most important sentence in their entire book is found in the epilogue regarding Dodd Frank:”Perhaps the most glaring omission in the new law was any mention of Fannie Mae and Freddie Mac.” (Kindle Locations 6849-6850)All four of those authors are progressives. When I’m talking about the powerful way the GSEs distorted risk perception, the evidence is so overwhelming I have to wonder how you can possibly claim: “it is the material cause that a libertarian economist would have to pick.” Do you need me to provide some quotes from Gretchen Morgenson? She is the most left-wing economics writer in the country after Paul Krugman. The fact that you have not mentioned her is very revealing about which of the two of us are driven by ideology. Regarding monetary policy, this is where you jump all around. The most powerful force affecting all of finance and you can’t seem to hold a steady position. You said: Monetary policy “facilitated” but did not “cause” the bubble. So let’s explore this in each of the cases you brought up. Where is the first mover in each example?”Monetary policy did not cause lenders to issue countless subprime loans” Will the lender lend without having money to lend? Of course not. How did the lender get the money? – from an investor. Why did the investor give the lender the money? Because it was the best investment available and his pension fund needs to pay retirees. Why was this the best investment available? Because others with less risk are too low a yield for me to pay my retirees. Why have the other assets been bid down? Because there is too much money chasing yield. Why is there too much money? I think you know the answer to that question. “slice and dice them” how does this cause a bubble?”insure them” remember we are talking about causing a bubble. How does insuring an asset cause a bubble?”engage in sloppy record keeping” Every CDO has a prospectus. How does the buyer’s misplacing his CDO’s owner’s manual cause a bubble?But then you go back to monetary policy: “Low short term interest rates led to low long term interest rates, so the “price” of financing a house went down.” OK so in mid paragraph you changed you mind and we agree now? Now after all this lament about how financiers caused a bubble, you defend it? It wasn’t so bad? “That in itself is not a bad thing is it? Especially at a time when US manufacturing jobs were being shipped overseas by the millions, so we needed something for blue collar people to do with themselves to earn a decent living.”You have been around the blogosphere right? you has seen some pretty ridiculous arguments. What do you make of the arguments you have tried to make? My god! just look at the one above! Monetary policy does not cause the bubble, because a) lenders of MONEY do b) what the loan looks like after it was made does. c) insuring the loan does d) when the buyer misplaces his prospectus that causes the bubble e) monetary policy does Therefore monetary policy does not cause the bubble. Are you kidding me?   It seems fitting that you would close with skepticism of knowledge in general, since you have argued every side of this thing. 

          • valley person

            From Gretchen Morgensen, Reckless Endangerment:

            “Of all the partners in the homeownership push, no industry
            contributed more to the corruption of the lending process than Wall
            Street. If mortgage originators like NovaStar or Countrywide Financial were the equivalent of drug pushers hanging around a schoolyard and the ratings agencies
            were the narcotics cops looking the other way, brokerage firms
            providing capital to the anything-goes lenders were the overseers of the
            cartel.

            Just as drug lords know that their products pose hazards to their
            customers, the Wall Street firms packaging and selling mortgage pools to
            investors knew well before their customers did that the loans inside
            the securities had begun to go bad.

            It was a colossal breakdown in the duty Wall Street owed to its investing customers.

            Years after the meltdown, investors began to understand how badly they’d been burned by Bear Stearns, Merrill Lynch, Lehman Brothers, Deutsche Bank, Greenwich Capital, Morgan Stanley, Goldman Sachs,
            and other smaller firms. Lawsuits against these firms alleging a
            dereliction of duty started cropping up in 2010 as investors began to
            realize that Wall Street’s secret loan assessments had identified severe
            problems in mortgages well before they stopped selling them.

            Unlike many other firms, Goldman Sachs went negative on the mortgage
            market in the fall of 2006, well before others in its industry. Using
            its own money, the firm began amassing major bets against the same
            dubious loans it was peddling to investors at that time. Goldman,
            therefore, profited immensely from the losses its clients absorbed,
            losses its own practices helped to create.”

            Note Eric, again one of your own sources says of ALL the partners, and by ALL we can assume she includes Fannie and Freddie, she says Wall Street (her shorthand, not mine) was the primary culprit.   

            Another excerpt:

            “While nobody mistook Wall Street banks for charity organizations, the
            degree to which these firms embraced and facilitated corrupt mortgage
            lending was stunning. Their greed and self-interest took the mortgage
            mania to heights (or depths, depending on your view) it could not
            possibly have reached without Wall Street’s involvement. And in so
            doing, Wall Street helped propel world financial markets to the brink of
            collapse.

            The voraciousness of these firms would also push the nation’s economy
            into its most serious recession in more than 75 years. Their avarice
            would finally, and forcefully, demonstrate how a noble idea like
            homeownership could be corrupted into something that so poisoned the
            global economy it was left in a semi-vegetative state.

            Recognizing how risky these loans were, Bear Stearns, Lehman Brothers,
            Goldman, and the rest were careful to bundle them with more traditional
            mortgages in the securities they were selling to investors. Prior to
            investing in the pools, prospective buyers were given only broad and
            generalized information about the loans inside them — details like
            average borrower credit scores and average loan-to-value ratios. That
            meant they rarely knew how many tricky loans they wound up owning. Until
            they started going bad, of course.

            “As usual, the ratings agencies were chronically behind on developments
            in the financial markets and they could barely keep up with the new
            instruments springing from the brains of Wall Street’s rocket
            scientists. ”

            And:

            “The creation of collateralized debt obligations as a sort of secret
            refuse heap for toxic mortgages created even more demand for bad loans
            from wanton lenders. CDOs, which were essentially big bundles of pooled
            mortgages, prolonged the mania — vastly amplifying the losses that
            investors would suffer and ballooning the amounts of taxpayer money that
            would be required to rescue companies like Citigroup and the American
            International Group.”

            And:

            “Borrowers who could prove that their incomes and assets were ample were
            pushed into more expensive loans that required no documentation.
            Mortgage brokers peddled them as easy and hassle-free. These and other
            tricks hurt borrowers. But they increased the industry’s and investment
            banks’ profits”.

            Do you want to keep playing this game? Dueling quotes from your own sources?

            Yes, my position remains that monetary policy was not the PRIMARY cause of the bubble. It may have ENABLED the bubble.

            I didn’t say the BUBBLE was not a bad thing. I said helping people get into home ownership through low interest rates was not a bad thing.  

            The BUBBLE was a bad thing in and of itself. But what was worse was its collapse, and how it left the entire financial system exposed as a big fraud.

          • Sorry if I kept you waiting my friend. I had several meetings yesterday.
            Regarding the cause of the financial crisis and the lessons to be learned, it is
            important t remember what argument of yours I am disputing. It is the capital
            letters argument: “FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED
            YOU GUYS TO CREATE THIS MESS”

            In pointing out that “this mess” is not inherent in finance and that regulatory
            policy can cause messes too, let’s remind ourselves of what I am not arguing. I
            am not arguing that bankers are not greedy. I am pointing out that all people
            are greedy, bankers included as well as politicians and regulators. I am not
            arguing that it was a good thing for CDOs to be treated as treasury bonds. I am
            pointing out that this could not have been possible if they did not have a GSE
            guarantee. I am thus perfectly in agreement with any claim by any source that
            greedy Wall Street bankers participated in the creation of the illusion that an
            OTC product can be traded as easily as a soybean futures contract. When one
            keeps this in mind, it becomes glaringly clear that you posted quotes from
            Reckless Endangerment that all support my argument.  

            “Of all the partners in the homeownership push, no industry 
            contributed more to the corruption of the lending
            process than Wall 
            Street. If mortgage originators like NovaStar or
            Countrywide Financial were the equivalent of drug pushers hanging around a schoolyard
            and the ratings agencies
            were the narcotics cops looking the other way,
            brokerage firms 
            providing capital to the anything-goes lenders
            were the overseers of the
            cartel.”

            This quote here brings us
            back to the old what is “Wall Street”? We have been here before. The context of
            this quote on page 263 regards events in 2006. Who is supplying NovaStar and
            Countrywide with the capital? That is to say who is supplying the drug to the
            local dealer? You guessed it, the GSEs. Wall Street is the cartel indeed!

            “Just as drug lords know that their products pose hazards to their 
            customers, the Wall Street firms packaging and
            selling mortgage pools to
            investors knew well before their customers did
            that the loans inside 
            the securities had begun to go bad.”

            In this case the sale is going the other direction. Who is the
            intermediary between the mortgage originator and the retail seller of the CDO?
            You guessed it, the GSEs.

            “It was a colossal breakdown in the duty Wall
            Street owed to its investing customers.” This quote comes from page 264. It is
            talking about real fraud, the failure to change the prospectus when a CDO’s
            mortgages did not match its geographic distribution and LTV ratios. I have told
            you before, that fraud should be prosecuted. It should be noted, that there was
            no deregulation of the Securities Act of 1933. The regulators are indeed
            looking the other way, because policymakers are emphasizing the promotion of
            homeownership, something both you and I seem to agree was a bad thing.

            “Years after the meltdown, investors began to
            understand how badly they’d been burned by Bear Stearns, Merrill Lynch, Lehman
            Brothers, Deutsche Bank, Greenwich Capital, Morgan Stanley, Goldman Sachs,
            and other smaller firms. Lawsuits against these
            firms alleging a dereliction of duty started cropping up in 2010 as
            investors began to realize that Wall Street’s secret loan assessments
            had identified severe
            problems in mortgages well before they stopped
            selling them.”

            This is on the next page and refers to the same fraud as your previous
            quote. It would be a red herring argument to say that I do not support
            regulations that prevent mislabeling of securities.

            “Unlike many other firms, Goldman Sachs went
            negative on the mortgage 
            market in the fall of 2006, well before others in
            its industry. Using 
            its own money, the firm began amassing major bets
            against the same 
            dubious loans it was peddling to investors at that
            time. Goldman, 
            therefore, profited immensely from the losses its
            clients absorbed, 
            losses its own practices helped to create.” 

            She is of course talking about the same trade you and I were talking about
            where Goldman was exonerated. This is hedging. It is a good thing. When we are
            looking for what went wrong, I identify the first four words in this quote
            “unlike other firms” other firms should have been managing their risk as well.

            You said “Note Eric, again one of your own sources
            says of ALL the partners, and by ALL we can assume she includes Fannie and
            Freddie, she says Wall Street (her shorthand, not mine) was the primary
            culprit.”

            When I am identifying the GSEs as the source of the distortion of risk
            perception, it has never meant that the GSEs were the only ones involved in the
            creation of CDOs. What I am saying is that they were the only ones able to give
            the CDOs the perception of a government guarantee.

            “While nobody mistook Wall Street banks for
            charity organizations, the 
            degree to which these firms embraced and
            facilitated corrupt mortgage 
            lending was stunning. Their greed and
            self-interest took the mortgage 
            mania to heights (or depths, depending on your
            view) it could not 
            possibly have reached without Wall Street’s
            involvement. And in so 
            doing, Wall Street helped propel world financial
            markets to the brink of
            collapse.”

            This is not something in dispute. What is in dispute is why it happens
            to us and not banking systems in Sweden, Switzerland, Singapore, and Hong Kong
            where their banker are no less greedy than ours but there is an equilibrium
            between the money supply and the demand for capital and no agencies of the
            government are subsidizing risk.

            “The voraciousness of these firms would also push
            the nation’s economy 
            into its most serious recession in more than 75
            years. Their avarice 
            would finally, and forcefully, demonstrate how a
            noble idea like 
            homeownership could be corrupted into something
            that so poisoned the 
            global economy it was left in a semi-vegetative
            state.”

            This avarice is a constant and it is not limited to banking. Human’s
            respond to prices. Distort the price of risk and capital will become
            misallocated. 

            “Recognizing how risky these loans were, Bear
            Stearns, Lehman Brothers, 
            Goldman, and the rest were careful to bundle them
            with more traditional 
            mortgages in the securities they were selling to
            investors. Prior to 
            investing in the pools, prospective buyers were
            given only broad and 
            generalized information about the loans inside
            them — details like 
            average borrower credit scores and average
            loan-to-value ratios. That 
            meant they rarely knew how many tricky loans they
            wound up owning. Until
            they started going bad, of course.”

            Imagine how the reporting would be more detailed if the people who
            bought the CDOs wanted to read the prospectuses and do proprietary research.
            Who bothers with such things if they think it is a Treasury bond with a higher
            yield? How did that happen? You guessed it, the GSEs.

            “As usual, the ratings agencies were
            chronically behind on developments 
            in the financial markets and they could barely
            keep up with the new 
            instruments springing from the brains of Wall
            Street’s rocket 
            scientists. ”

             I have never mentioned rating
            agencies because I don’t know anybody who has ever taken them seriously. Who
            takes Morningstar’s ratings of mutual funds seriously? The rating agencies have
            been around for a long time, but ERISA seemed to turn them into rubber stamps
            when it changed their business model from selling their research to selling
            their services for rating structured products.

            “The creation of collateralized debt
            obligations as a sort of secret 
            refuse heap for toxic mortgages created even more
            demand for bad loans 
            from wanton lenders. CDOs, which were essentially
            big bundles of pooled 
            mortgages, prolonged the mania — vastly
            amplifying the losses that 
            investors would suffer and ballooning the amounts
            of taxpayer money that
            would be required to rescue companies like
            Citigroup and the American 
            International Group.”

            Like Gillian Tett, she is
            talking about liquidity here. AIG and Citigroup were taken under by margin
            calls on the CDSs of the investment banks.

            “Borrowers who could prove that their incomes
            and assets were ample were 
            pushed into more expensive loans that required no
            documentation. 
            Mortgage brokers peddled them as easy and
            hassle-free. These and other 
            tricks hurt borrowers. But they increased the
            industry’s and investment 
            banks’ profits.”

            This is an issue we have not yet discussed. I’ve always wanted to meet
            these people who somehow get a loan they don’t need. Are these the people who
            walk into a grocery store to get a gallon of milk and buy high priced end-cap
            things they don’t need? I don’t think you and I disagree on the need for
            regulations preventing fraud, but not all impulsive decisions rise to the level
            of fraud. I think there were likely predatory borrowers out there too.

            You said: “Do you want to keep playing this game?
            Dueling quotes from your own sources?”

            There really is nothing to duel over here. You have provided wonderful
            quotes about how investors’ incentive for due diligence drops when risk has
            been subsidized. Since you have read the book, I am sure you now know that she
            spells out in no uncertain terms that the GSEs caused the crisis. Her whole
            book is structured in a chronological way to identify the first mover, that set
            in motion the conditions that led to these problems that we both agree are
            problems. Perhaps this is why all your quotes come toward the end of the book.
            You seem to have avoided the beginning of the book when she explicitly
            identifies the first-mover, a fateful set of bipartisan decisions that gave
            Fannie Mae its lobbying and market power to dominate both Congress and Wall
            Street. I will provide whole passages of hers in their full context in a
            separate post.

            “Yes, my position remains that monetary policy was
            not the PRIMARY cause of the bubble. It may have ENABLED the bubble.” Let me try and find a way to agree with you here.
            Perhaps you are saying that a bubble was inevitable somewhere, but it did not
            have to be in housing? Can we agree on that?

            “I didn’t say the BUBBLE was not a bad thing. I
            said helping people get into home ownership through low interest rates was not
            a bad thing.”

            Since the subsidizing of homeownership has incurred such higher costs on
            society, this seems like a strange thing for you to say. I thought we were both
            skeptical of the cult of homeownership. Even for people who romanticize
            suburban subdivision McMansions, whatever advantages they are trying to tout,
            seem to pale in comparison to the disadvantages of macroeconomic instability. In
            the end of the other post you seemed to even lament a nation of renters. Are
            mortgage holder not renters? Are they not renting the money? Are you sure that
            home ownership has not been a net cost on the American middle class?

            “The BUBBLE was a bad thing in and of itself. But what was worse was its
            collapse, and how it left the entire financial system exposed as a big fraud.” 

            Imagine a steadier
            rate of economic growth with higher interest rates if the preponderance of
            people wants to consume more than they earn or lower interest rates if the preponderance of people
            wants to consume less  than they earn, sustaining macroeconomic equilibrium without asset class bubbles. There
            are countries that have this and their financiers are no less greedy than ours.
             

          • The primary reason Morgansen’s book has caused such a stir,
            is that it was shocking for such a left-wing writer to be so explicit in
            calling out the GSEs and explicitly identifying the causal roll they played.
            Hers is more a book about their lobbying to shape the mortgage market into such
            a cash cow for stake holders at every level. While Mclean writes more about the
            way the GSEs distorted risk perception among investors, Morgensen writes about
            how the GSEs distorted lawmakers and housing policy. She identifies the
            National Partners in Home ownership Program as the moment regulators, bankers,
            and politicians all got in bed together. The entire focus of her book is laid
            out lucidly in the first few chapters. Here is the thrust of her thesis in its
            full context:

             

            “Rather than pursue its home ownership program alone, as it
            had done in earlier efforts, the government enlisted help in 1995 from a wide
            swath of American industry. Banks, home builders, securities firms, Realtors—all were asked to pull together in a partnership made up of 65 top
            national organizations and 131 smaller groups.

             

            The partnership would achieve its goals by “making homeownership
            more affordable, expanding creative financing, simplifying the home buying
            process, reducing transaction costs, changing conventional methods of design
            and building less expensive houses, among other means.”

             

            Amid the hoopla surrounding the partnership announcement,
            little attention was paid to its unique and most troubling aspect: It was
            unheard of for regulators to team up this closely with those they were charged
            with policing.

             

            And nothing was mentioned about the strategy’s ultimate
            consequence—the distortion of the definition of homeownership—gutting its role
            as the mechanism for most families to fund their retirement years or pass on
            wealth to their children or grandchildren.

             

            Instead, in just a few short years, all of the venerable
            rules governing the relationship between borrower and lender went out the
            window, starting with the elimination of the requirements that a borrower put
            down a substantial amount of cash in a property, verify his income, and
            demonstrate an ability to service his debts.

             

            With baby boomers entering their peak earning years and the
            number of two-income families on the rise, banks selling Americans on champagne
            hopes and caviar dreams were about to become the most significant engine of
            economic growth in the nation. After Congress changed the tax code in 1986,
            eliminating the deductibility of interest payments on all consumer debt except
            those charged on home mortgages, the stage was set for housing to become
            Americans’ most favored asset.

             

            Of course, banks and other private-sector participants in the
            partnership stood to gain significantly from an increase in homeownership. But
            nothing as crass as profits came up at the Partners in Homeownership launch.
            Instead, the focus was on the “deeply-rooted and almost universally held belief
            that homeownership provides crucial benefits that merit continued public
            support.” These included job creation, financial security (when an
            individual
            buys a home that rises in value), and more stable neighborhoods (people don’t
            trash places they own). In other words, homeownership for all was a
            win/win/win.

             

            A 1995 briefing from the Department of Housing and Urban
            Development did concede that the validity of the homeownership claims “is so
            widely accepted that economists and social scientists have seldom tested them.”
            But that note of caution was lost amid bold assertions of homeownership’s
            benefits.

             

            “When we boost the number of homeowners in our country,”
            Clinton said in a 1995 speech, “we strengthen our economy, create jobs, build
            up the middle class, and build better citizens.”

             

            Clinton’s prediction about the middle class was perhaps the
            biggest myth of all. Rather than building it up, the Partners in Homeownership
            wound up decimating the middle class. It left Americans in this large economic
            group groaning under a mountain of debt and withdrawing cash from their homes
            as a way to offset stagnant incomes.

             

            It took a little more than a decade after the partnership’s
            launch for its devastating impact to be felt. By 2008, the American economy was
            in tatters, jobs were disappearing, and the nation’s middle class was imperiled
            by free-falling home prices and hard-hit retirement accounts. Perhaps most
            shocking, homeownership was no longer the route to a secure spot in
            middle-class America. For millions of families, especially those in the lower
            economic segments of the population, borrowing to buy a home had put them
            squarely on the road to personal and financial ruin.

             

            But what few have
            recognized is how the partners in the Clinton program embraced a corrupt corporate
            model that was also created to promote homeownership. This was the model
            devised by Fannie Mae, the huge and powerful government-sponsored mortgage
            finance company set up in 1938 to make it easier for borrowers to buy homes in
            Depression-ravaged America. Indeed, by the early 1990s, well before the
            government’s partnership drive began, Fannie Mae had perfected the art of
            manipulating lawmakers, eviscerating its regulators, and enriching its
            executives. All in the name of expanding homeownership.

             

            Under the direction of
            James A. Johnson, Fannie Mae’s calculating and politically connected chief
            executive, the company capitalized on its government ties, building itself into
            the largest and most powerful financial institution in the world. In 2008,
            however, the colossus would fail, requiring hundreds of billions in taxpayer
            backing to keep it afloat. Fannie Mae became the quintessential example of a
            company whose risk taking allowed its executives to amass great wealth. But
            when those gambles went awry, the taxpayers had to foot the bill.

             

            That failure was many
            years in the making. Beginning in the early 1990s, Johnson’s position atop
            Fannie Mae gave him an extraordinary place astride Washington and Wall Street.
            His job as chief executive of the company presented him with an extremely
            powerful policy tool to direct the nation’s housing strategy. In his hands,
            however, that tool became a cudgel. With it, he threatened his enemies and
            regulators while rewarding his supporters. And, of course, there was the fortune
            he accrued.

             

            Perhaps even more
            important, Johnson’s tactics were watched closely and subsequently imitated by
            others in the private sector, interested in creating their own power and profit
            machines. Fannie Mae led the way in relaxing loan underwriting standards, for
            example, a shift that was quickly followed by private lenders. Johnson’s company
            also automated the lending so that loan decisions could be made in minutes and
            were based heavily on a borrower’s credit history, rather than on a more comprehensive
            financial profile as had been the case in the past.” (p. 2-5)

             

            In your attempt to find
            passages that included the description of a problem that did not mention the
            GSEs within the bracket of your quote, you somehow managed to miss the entire
            thesis of Morgensen’s book. This is not an issue of the GSEs were bad and the
            private banks were good. It is an issue of how GSEs act as a broker of
            corruption that is able to engage in what economist call “regulatory capture.” She
            sounds quite harsh on Clinton, but that is only because she is identifying the
            origination of this national home ownership strategy. It was Bush that mixed
            subprime into this cocktail. Here is another clear delineation of CAUSATION by
            Morgensen:

             

            “How Clinton’s calamitous
            Homeownership Strategy was born, nurtured, and finally came to blow up the
            American economy is the story of greed and good intentions, corporate
            corruption and government support. It is also a story of pretty lies told by
            politicians, company executives, bankers, regulators, and borrowers.” (p5)

             

            Every one she lists there
            is greedy: politicians, company executives, bankers, regulators, and borrowers,
            but greed is a constant. The independent variable here is what we get when we
            allow GSEs to acts as intermediaries between mortgage originators and
            investment banks to turn high risk assets into what investors perceive as low
            risk Treasuries.

             

            The rest of her book builds
            upon this initial moment in 1995, showing how this corruption swelled with the
            GSEs’ growing market power and lobbying power. There is something you and I
            agree on, companies like Goldman Sachs will do anything for a buck, but I’m not
            sure you recognize that Goldman Sachs cannot lobby so directly and so
            effectively the way a government sponsored enterprise can. A financial sector
            without GSEs is a very different thing than one with them:

             

            “Under Johnson, Fannie Mae
            led the way in encouraging loose lending practices among the banks whose loans
            the company bought. A Pied Piper of the financial sector, Johnson led both the
            private and public sectors down a path that led directly to the credit crisis
            of 2008. It took more than a decade to assemble the machinery needed to create
            the housing mania. But it took only a year or two for the juggernaut to
            collapse in a heap, destroying millions of jobs and retirement accounts, and
            devastating borrowers” (P10).

             

            I’ve got lots of time this
            weekend, and my schedule is light next week. Let’s hash out a common
            understanding of this crisis. A lot of what Fannie Mae was doing could be
            called “deregulation” but it was really a redirection of public policy towards
            an intentional goal. Distorting market risk perception was a means toward that
            goal. If you want trouble in an economy misprice risk. I have a keen
            understanding of how regulation can create harms of its own. That is a
            realistic position any data driven economist would take. Don’t confuse this
            with a dogmatic rejection of regulation out of hand. In regulating the
            financial sector, we need regulations that prevent fraud, but we need to avoid
            regulations that create moral hazard. 

          • valley person

            People are waiting? What…have they been phoning in? I think its down to just us Eric. Nevertheless….

            1) My response is that if Glass Steagall made investment banks more risky…so what? They had 66 years to design their practices to account for those risks.  And when G-S was repealled, they could have merged or become commercial banks. Those that chose to continue operating as before, and then became over leveraged in lousy mortgage instruments courted disaster and found it, much to their surprise.

            2) Large banks have advantages over small ones. They can borrow cheaper. Besides, small business failure rates in any industry are higher than large business failure rates.

            3) I don’t know. But I’m not sure what your point is anyway. Is it that the garbage mortgage packages were not so bad after all, even after the crash? That the only problem is their lack of liquidity? If that is your point, I answered it. Liquidity matters in finance. Its why investors diversify and hold cash, even at low yields.

            4) Subprimes were “rare” prior to 2004? I guess that depends on your definition of rare. Countrywide, the private sector poster child for  this mess, was issuing subprimes left and right long before 2004. Subprimes steadily increased as a share of mortgages from the mid 90s (5%) to 2000 (13% to 2006 (20%). Packaging these into securities increased from 30% to over 80%.

            Your “material cause” is not the material cause that your own sources identified. But it is the material cause that a libertarian economist would have to pick. The “material cause” they id’d was the creation of new financial instruments that changed the way mortgages were issued, chopped up, bundled, resold and insured AND the lack of a proper regulatory framework AND a failure to act within the regulations that existed. 

            5) I don’t know. Germany is a nation of renters so was probably less exposed. Spain and Ireland (the latter the former poster child for the magic of low corporate tax rates by the way) crashed pretty hard. As did Great Britain.

            6) Greenspan failed to recognize the national housing bubble by his own admission, because he believed the market could not over value a commodity for very long and would self correct. The Fed had the power to demand a margin requirement for housing finance. They could have established a 20% down, anything less requiring mortgage insurance. In other words, they could had stopped or curtailed subprime lending at least temporarily to help gently deflate the bubble. He could also have increased capital requirements n banks and other mortgage originators, both of which would have slowed the forming of the bubble. 

            7) I don’t understand the question. Why would the Fed be any less independent if it used its available powers to act in the public interest?

            8) Ask Stiglitz.

            9) I don’t know if the Born proposal would have had negative consequences, and I don’t know if it would have prevented the financial industry from finding other ways to shoot itself and us in the foot, as they seemed and still seem insistent on doing. We do know what failure to adopt her proposal led to. I doubt that following her advice would have created something worse than the worst financial crisis since the 1930s.

            “The difference between a casino and a financial market is that if you
            make the right decisions as an investor, earning a return on your
            savings is inevitable, while in a casino no matter what you do you are
            guaranteed to lose money.”

            Really? If I make a decision to hold on 20 in blackjack and win, I am guaranteed to lose? I don’t think so Eric. Some casino gambling, like slots, is pure chance and the odds are stacked against you. Other casino gambling is skill, and you can improve your odds and walk away ahead.  On the other hand, in your world of finance, if you place your bet with Bernie Madoff, or on Countrywide or Lehman, or other companies highly rated by Wall Street, you can easily walk away with nothing. And the worst part is you were sold a bill of goods on how “safe” your money was. While the Casino makes no such claim.

            “What makes you think that I don’t use my skills to find companies making or doing something useful?”

            I based my comment on the example you gave. You didn’t give any example of doing anything useful. I hope you find occasion to do so.

            “Would you deny the ability to manage financial risk?”

            That’s a silly question. Everyone already has the ability to manage their financial risk. The real question is whether certain financial instruments widely used end up shifting the risk from one or a few companies to the economy at large. The answer in the case of the financial crisis, again according to sources you cited, is yes. That is what happened.

            “Why attribute agency to the financiers?”

            Because they are the ones who allocated the capital, hid and shifted the risks, and brought the house down. I didn’t absolve government by the way. I merely place the primary blame on the financiers. Government failed in multiple ways as well.

            “Why blame financiers when there is empirical evidence asset bubbles are caused by monetary policy.”

            Because a lot of other evidence suggests that monetary policy facilitated, it didn’t CAUSE this particular asset bubble. Monetary policy did not cause lenders to issue countless subprime loans, slice and dice them, resell them, insure them, engage in sloppy record keeping, and so forth. Low short term interest rates led to low long term interest rates, so the “price” of financing a house went down. That in itself is not a bad thing is it? Especially at a time when US manufacturing jobs were being shipped overseas by the millions, so we needed something for blue collar people to do with themselves to earn a decent living. 

            “It’s as if you want to blame a banker regardless of the facts …”

            No Eric. The facts are clear. With due respect, its your ideology and perhaps participation in the finance world that moves you to shift the primary blame to government.

            “Why flee from established social science, blaming everything on Shylock? ”

            Two points. First is that physical science and social science are very different entities. The physical science of global warming is overwhelming. Second the primary cause of the housing bubble and the financial collapse is clearly not established social science. For one thing, the history of it is still too fresh. As evidence, I present your own sources, who identified the same primary causal agents I did.

             

  • valley person

    Starting a new thread to avoid the mysterious shrinking paragraph space.

    Points where we seem to agree:
    1) Government policies that encourage(d) home ownership resulted in over investment in housing over many years, compared to what an entirely free market would have created.

    2) A big part of that policy has been mortgage guarentees and re-purchases by Fannie and Freddie, or GSEs. Government policy to further increase the percent of Americans owning
    homes from the mid 90s through the Bush years at least enabled, or
    created the conditions that private financiers (and borrowers) used to
    over invest in housing, a result of which was the bubble.

    3) Fed policy to maintain low  interest rates through the early 2000s helped increase the shift of more capital to housing.

    4) Greed is widespread among humans (as is altruism by the way).

    5) There were, as you say “predatory borrowers” as well as lenders playing this game. It takes more than one to tango.

    Where we seem to disagree:

    1) The role of new financial instruments, developed by the private sector, played in shifting capital to housing, hiding risk, and creating a systemic crisis. In particular the slicing and dicing of subprme mortgages into bits, securitizing them, mixing them with better mortgages, insuring them (with the insurance provided by companies also deeply invested in the very instruments they were insuring, hence the Titanic analogy,) and so forth.

    2) Which was chicken and which egg in creating the bubble, GSEs or the private financial instruments and their expansion.

    3) Whether investment bubbles are an inherent feature of markets, or whether these are creatures of government policy distorting markets. 

    4) The extent to which the American banking system is over or under regulated, and what particular regulations led to which problems with respect to the financial crisis.

    5) Whether government policy to promote home ownership (or any other product) is inherently a bad thing because it distorts free markets.

    6) Whether investors buying the repackaged subprimes thought they were buying an absolute federally backed package of loans. (For the record, I don’t think this was the case, since there was no explicit guarentee. These were not T-bills).

    Taking our disagreements one by one:

    1) Subprime lending was invented by the mortgage industry, not by government. It increased dramatically in the 2000s, enabled by securitization. Lenders made their money off of originating, repackaging, and selling loans and began to care less about the quality of each loan. By 06 75% of all mortgages became securitized, with a third of these subprimes. The use of credit default swaps increased by an estimated 100 times from 1998-2008, amounting to some 40 trillion dollars.  

    2) Without the new financial instruments and a change in how the  private financial world evaluated and managed risk, there would have been no housing bubble. In the end it was private capital chasing profits based on the next fool in the door. .

    3) Investment bubbles are an inherent feature of free market capitalism. They would occur with or without government intervention or regulation, and have over the years. They result from a  natural herd mentality and money chasing more money. 

    4) I go with under regulated. The under regulation allowed what should have been boring banks getting into high risk finance, and failed to keep up with changes.

    5) I don’t view free markets as inherently good. With apologies to Adam Smith and others, an accumulation of individual interests do not add up to a public interest. Case in point, carbon accumulation in the atmosphere. No individual can solve this problem. Its a market failure of potentially catastrophic proportions.

    In the case of housing, its complicated. We came out of the 1930s chastened about free markets. We pulled together as a nation to fight and win a significant war. We rewarded veterans with low interest loans to buy homes. We enjoyed nearly 3 decades of mostly uninterupted prosperity. Home ownership became the norm, and became the most solid investment for most Americans. We also had a lot of red lining and other discriminatory practices that left a big segment of Americans out. Over time we expanded programs to help more people get a slice of the pie.

    But we also entered a period of middle class economic stagnation, so a gap opened between available income and the true cost of housing ownership. This is way too complex to litigate here. I’ll just say that by and large getting more people into home ownership was well intended, and that few alternatives to expand the middle class are available to us.

    6) I do not believe that buyers of privately produced, non government guarenteed, securitized subprime mortgage packages were  tricked into this by thinking they were guarenteed. I think they bought these packages because there was a mis-perception in the private financial world that American housing was a stable investment that could not decline in value, and that all bets were covered by derrivatives and other instruments. In other words, the private financial world thought it had created a bomb proof investment vehicle, which is why it became so over leveraged. 

    The more you distance the link between borrower and lender, the more you create uncertainty and increase risk. This uncertainty and risk then has to be made up for by creating additional instruments, like derrivatives, and increasing reliance on the bond raters, whom you discount. Critics of the role of private finance in the bubble, and the failure of government to choose to regulate, focus largely on this change in the banking and finance industry with respect to the creation of the housing crisis. 

    This goes to the heart (I think) of the OWS protests, and explains why they are now encouraging people to get their money out of the large banks and into the small ones. They want to get more “community” into finance as a way of mitigating the role of international finance, which they (for good reason) do not trust. They want to see capitalism moderated and better harnessed to social ends. Utopian? Perhaps. But it is equally utopian to believe that unfettered markets will result in net good.

    • A1-5 points we agree on
      D1-6 points we disagree on
      P1-19 previous points

      D1 “Subprime lending was invented by the mortgage industry, not by government.” This is a moot point since the problem we are addressing is how the GSEs distorted a private market. You dropped P4 which showed the material impact the GSEs had in moving into subprime. Indeed you just restated my evidence from P4 when you mention: “By 06 75% of all mortgages became securitized, with a third of these subprimes.”

      “It increased dramatically in the 2000s, enabled by securitization.” You must be thinking that securitization attracted more capital than other forms of financing banks and thus you think it provided a necessary condition to inflate the bubble. For this to be true, we would only see real estate bubbles formed with securitization. This is demonstrably false because the two most storied real estate bubbles were in Japan and Sweden. Neither banking systems had securitization at that time. Banks were able to attract capital by selling higher yielding CDs to originate a swelling portfolio of bad debt. Investors merely bought CDs rather than CDOs.

      “Lenders made their money off of originating, repackaging, and selling loans and began to care less about the quality of each loan.” This is very intuitive to many people but it too is demonstrably false. This ignores the scrutiny that investors place on CDOs without the perception of a government guarantee. This scrutiny is evident in the way risk is rationally priced in the many other types of assets that are securitized into OTC products, but lack the perception of a government guarantee. It also ignores that fact that small banks and credit unions without access to the securitization market have shown no greater judgement in their underwriting. Community bankers were more than happy to lend to house flippers with negative amortization products. Perhaps they were even more inclined to do so if their kids went to the same school. 

      “The use of credit default swaps increased by an estimated 100 times from 1998-2008, amounting to some 40 trillion dollars.” We really have not talked about CDSs, probably because they were so peripheral to the crisis. If we had you might be surprised that I agree with the need to regulate them, but it should not be surprising. It is a matter of fraud for one party to sell an insurance product knowing they could not pay all their claims during a disaster. 

      D2. “Without the new financial instruments and a change in how the  private financial world evaluated and managed risk, there would have been no housing bubble. In the end it was private capital chasing profits based on the next fool in the door.” Now we are getting somewhere. Let’s break this down. 

      “Without the new financial instruments” this claim is of course contingent on D1. When it is removed by my counter arguments, all that is left is the mispricing of risk. You have already spelled out for us the condition that would have prevented the mispricing of risk, when you said if interest rates would have been higher “we wouldn’t be having this discussion.” 

      Knowingly or not you have just now hit upon another premise to support my monetary argument with this fine locution: “In the end it was private capital chasing profits based on the next fool in the door.” Private capital is always chasing profits, but it only behaves like a fool in a cyclical manner. This cycle correlates too strongly with the expansion and contraction of the money supply to be ignored. When the money supply expands, too many investors start chasing too few worthy investments. It becomes a seller’s market. If everybody had to have apples, don’t be surprised to find people rush to buy bad apples when they buy faster than they can inspect. Credit markets work the same way. Pension funds have to make profits. Increase the money supply and all the worthy investments get bid up too high in price offering too low a yield forcing investors to take on more risk just to meed their obligations. It is in this environment that capital is missallocated. You have dropped the evidence in P5 which shows it does not have to be this way. 

      D3. “Investment bubbles are an inherent feature of free market capitalism.” This cannot be true if P5 is true. Most market economies engage is some form of counter-cyclical monetary policy. So there is a correlation, but if you ignore the placebo evidence you cannot simply restate this assertion. 

      D4. “I go with under regulated.” What do you have to go on? You dropped P1, P5, P6, P7, P8 (you did not just drop P8 you threw this one under the bus), P9, P10, P11, P12, P13, P14, and P15. 

      “The under regulation allowed what should have been boring banks getting into high risk finance, and failed to keep up with changes.” This cannot be true if P2 is true. It is easy to restate your assertion, but it must be hard to address the catastrophe that we faced in 1980 when the Bank Act of 1966 had to repealed, and how the failure to include thrifts in the repeal created the S+L crisis. It was boring banks that took down the Swedish and Japanese economies twenty years ago. You have dropped P3 which explains why Wells Fargo, Keycorp, JPMorgan, and USBancorp found themselves in a position to opt out of TARP money but boring banks across America continue to take their TARP money down with them. 

      D5. “I don’t view free markets as inherently good.” Neither do I; I don’t place a normative value on gravity either. Do you view politicians as inherently good? Gretchen Morgensen’s book may actually threaten Barney Frank’s career. There are two forms of cooperation, voluntary exchange and coercion. There is need for coercion to prevent people from harming other people. If you ignore the ability of public policy to create negative externalities of its own you might find yourself in a position of lamenting the emission of carbon into the atmosphere while simultaneously defending the way we have been subsidizing sprawl on a massive scale. 

      “Home ownership became the norm, and became the most solid investment for most Americans.” Are you sure this was a solid investment or was it a net cost? Remember mortgaged home owners simply replace renting an apartment for renting the money to buy a home. It is renting with debt. 

      Home ownership is a net cost, sucking cash flow out of middle class budgets. A) take a look at the amortization schedule. Keep in mind that when people refinance it restarts the amortization. Take a look at any mortgage statement. Subtract the amount going to principal from the total amount of the monthly mortgage payment. Take that number and divide it by the total monthly payment. Few home owners have a number less than 80%. That is to say 80% or more of their monthly payment is a form of rent. B) Their home owner’s insurance is a form of rent. C) The risk that a home owner bears that the value of their home will lose value is a form of rent. D) The transaction costs they incur when they buy and sell their house is a form of rent. E) The property tax is rent they pay to the state. F) Anyone who has foregone a promotion or a better job because of the higher relocation costs of home ownership has paid rent in the form of an opportunity cost. F) Anyone who has to commute longer to work due to their home’s affordably remote location has paid rent in the form of the monetary value of his time and the price of fuel. G) All the money spend maintaining a home and the monetary value of the time spent doing it is a form of rent. H) The higher energy costs of heating and cooling a home rather than an apartment is a form of rent. 

      That was just the impact on the personal finance of the American middle class. I think you are aware of the environmental impact as well as the inefficiencies sprawl imposes on the delivery of public services. 

      D6. “I do not believe that buyers of privately produced, non government guarenteed, securitized subprime mortgage packages were  tricked into this by thinking they were guarenteed.” This is a remarkable thing to fall back on considering the evidence that I have presented you with. Remember we are talking about liquidity here, not solvency. You cannot drop P2 and P3 and maintain it is the case that: “The more you distance the link between borrower and lender, the more you create uncertainty and increase rise.” This brings us back to the problem of restating conclusions but not supporting them with premises. 

      • valley person

        “This is a moot point…”

        It may be moot to you, but its not moot to my case. The private financial industry created all the instruments required to create and sustain the housing bubble, with subprimes being the most important.

        “You must be thinking that securitization attracted more capital than
        other forms of financing banks and thus you think it provided
        a necessary condition to inflate the bubble.”

        Bingo.

        Japan may not have had securitized loans, but it didn’t need them. It had tons of capital flowing into real estate chasing rising values. And without GSEs.

         “It also ignores that fact that small banks and credit unions without
        access to the securitization market have shown no greater judgement in
        their underwriting.”

        I’m not sure that is true. My own credit union was way more savvy than Washington Mutual when I was refinancing. It’s likely that the smaller banks simply fell victim to the collapse in the broader economy. Wall Street dragged main street down in its whirlpool. 

        “It is a matter of fraud for one party to sell an insurance product
        knowing they could not pay all their claims during a disaster. ”

        The disaster in this case was a complete collapse of the entire market that AIG and others had “insured.” Was it fraud? I don’t know. If a comet had hit, that wouldn’t have been a fraud. Point is, the insurance turned out to be pretty worthless because it was way under capitalized. Whether someone now gets busted for fraud seems moot. The damage was done by the fact of insurance that could not be redeemed.

        “Private capital is always chasing profits…”

        Yes of course, but only now and then does this turn into systemic risk. The high tech bubble was a systemic risk, as was the housing bubble, as was the S&L crisis, as was the Asian financial crisis. Beanie Babies were not.

        “It is in this environment that capital is misallocated.”

        That isn’t good enough for me. All you are doing is making a case for perpetual tight money to prevent private parties from misallocating their capital. I suppose we could just remain poor, live hand to mouth, and avoid bubbles this way. But I don’t see that path as very appealing. Though Ron Paul seems to think it is. Eat your spinach and only spinach is not a winning program.

        “This cannot be true if P5 is true.”

        Well, I’m lost on what P5 was. But the economic history of capitalism is littered with investment bubbles, including the 19th century that had next to nothing in terms of regulation. I shouldn’t have to prove the obvious.

        “What do you have to go on? ”

        The lack of applied regulations during the bubble. Greenspan and Bush chose to let it ride. We have been over this ground enough.

        “I don’t place a normative value on gravity either.”

        Well then you should. Without gravity there are no suns, no planets, no life as we know it, no typing, and no free markets (or government regulation).  You should give thanks for gravity every now and then.

        “Gretchen Morgensen’s book may actually threaten Barney Frank’s career. ”

        Barney Frank? He was in the minority party from 1994 through 2006, which is to say the entire housing bubble and collapse. I doubt he had much influence. Morgensen’s charges against Frank are:

        1) He argued against tighter capital requirements for Fannie & Freddie in 1992. OK. BFD.

        2) He helped is friend get a job with Fannie. Perhaps this true. Somehow I doubt it is the first or last time a Congressman helped someone get a job.

        3) His reform bill did not go far enough to end too big to fail. I agree with her on this. But its hardly a firing offense given the other party is against any increased regulation of financial institutions.

         “If you ignore the ability of public policy to create negative externalities of its own …”

        I don’t ignore it at all. In my work I deal with this sort of thing all the time  (environmental impact analysis). My argument with you is about primary causes of the financial crisis. Public policy no doubt helped feed the beast. But the beast was the private sector.

        “Are you sure this was a solid investment or was it a net cost? ”

        I’m reasonably sure it was a solid investment for most home owners measured over many decades. I’m also sure that for a lot of people, particularly those late to the bubble party or those who refinanced to maintain spending, it was not a good investment at all.

        If you go back to the good old days, buying a house to live in is not like other investments because of the direct utility value of the house, as well as its equity value. Yes, a house is also a burden.  But the hassle factor of renting needs to be factored in. Landlords are not benign creatures.

        Renters also fork out for property taxes, insurance, run risks, and so forth. They just do so less directly.  And like it or not, there is a social stigma to being a renter. If you don’t believe me, try showing up at a neighborhood meeting and see how well you are received.

        In any case, arguing the economics of home ownership in America is a waste of time.   Its a fact of life that our nation chose to build a middle class society based on home ownership, and structured tax and fiscal policies to support this. If you want to try and unravel that thread, good luck.

         

        • D1 When public policy distorts a private market, it is a moot point to say the effects of the distortion are inherent to the private market. Union Pacific Railroad’s bust was not caused by market forces neither was Solyndra’s. This is even easier to demonstrate in the area of subprime lending. Remember you not only dropped P4, but you brought up the evidence of the GSEs’ distortion when you said: “By 06 75% of all mortgages became securitized, with a third of these subprimes.” 

          “Japan may not have had securitized loans, but it didn’t need them. It had tons of capital flowing into real estate chasing rising values.” I agree, monetary policy can form a bubble all by itself. Still it is very difficult to form a residential real estate asset class bubble when there are so many more liquid assets out there to absorb increases in the money supply. No GSEs in Japan? What do you suppose the Government Home Loan Corporation was when it was created by the Home Ownership Law of 1950? Japan had GSEs on stilts like MITI. And then there was Sweden before 1991. I agree with your analysis here, but this was not a very good response to my point which I will repeat: “For this to be true, we would only see real estate bubbles formed with securitization … Banks were able to attract capital by selling higher yielding CDs to originate a swelling portfolio of bad debt. Investors merely bought CDs rather than CDOs.” I can see why you would want to ignore this point. Assertions of causal claim are disproven by the existence of alternate causalities. 

          Your evidence that small banks and credit unions have higher underwriting standards is an anecdote of your own refinancing? Did you refinance after 2008? Aren’t everybody’s standards higher now? Anecdotally you would have found high standards at Wells Fargo if you had refinanced with them 2006. Anecdotes aside, the evidence that supports my assertion is that list of bank failures I provided you and how they contrast with Wells Fargo, JPMorgan, Keycorp, and USbancorp’s attempt to opt out of TARP. 

          “It’s likely that the smaller banks simply fell victim to the collapse in the broader economy.” How many bank failures did we have in the last two recessions? If banks were simply experiencing a drop in business like other firms of all size in all sectors do in a recession, why haven’t these hundreds of small banks and credit unions been able to close offices and downsize like banks have done in previous recessions? The FDIC is seizing them for their mortgage loan losses. If our entire banking system looked like this we would have had a far worse crisis, that is to say it would have looked like Japan and Sweden. 

          Regarding CDSs, “The damage was done by the fact of insurance that could not be redeemed.” The reason we have not been talking about CDS so far is because this damage was peripheral to the crisis. The absolutely worst thing that could have happened is that AIG’s counterparties would have become its shareholders. The primary reason this was so peripheral, the other sellers of CDS had an adequate capital cushion to meet their obligations. There were many other sellers of CDSs with even greater exposure that had no trouble paying. Let’s compare this with Brooksley Born’s proposal that every derivative of every kind were to be cleared through a giant GSE. We know how good GSEs are in lobbying to reduce their capital requirements. Imagine what a systemic disaster that would have been. If we had a huge GSE with a monopoly over the derivative business with the prudence of Fannie Mae, then CDSs would have played a central role in this crisis. This is why her proposal was rejected and perhaps the reason why you have ignored this point when you kept dropping P15. No reason to bring more risk into the system when simply mandating re-insurance would suffice. Again if AIG never failed, we would still have a huge commercial banking problem on our hands, one that continues to this day. 

          D2. We are really starting to iron out some common understanding now with the policy choices available to us when we get real about monetary policy. P5 was the placebo evidence from countries like Sweden, Switzerland, Singapore, and Hong Kong. They keep their M1 growth proportional to GDP growth avoiding asset class bubbles. Sweden made a big move into high tech in the 1990s but had no tech bubble. Singapore enjoyed the growth of emerging Asia, but did not participate in the southeast Asian financial crisis. These four countries hardly remain poor or live hand to mouth. We are simply talking about having interest rates that reflect our economy’s savings rate. 

          D3. By acknowledging that a market economy with the right monetary policy would not have bubbles, you are acknowledging that this previous statement of yours is not true: “Investment bubbles are an inherent feature of free market capitalism.” 

          D4. Your assertion that underregulation caused this crisis has been repeated over and over again, but evidence has not been forthcoming. Indeed, when pressed on this most central part of your capital letters argument, you provided very little and you ignore all the counter evidence when you dropped P1, P2, P3, P5, P6, P7, P8, P9, P10, P11, P12, P13, P14, and P15.

          D5. Regarding your ignoring the risks that regulations impose on the system. I recall a “so what” attitude towards it. This was confirmed by your dropping P1, P2, P3, P5, P6, P7, P8, P9, P10, P11, P12, P13, P14, and P15 and yet restating your conclusion that the crisis was caused by underregulation. Every regulation you have mentioned presented more risk than the problem it tried to solve for. When presented with evidence that is the case, you ignore it only to restate your conclusion. 

          Compare that to your acknowledgement that better monetary policy would have avoided the crisis entirely. This is made all the more salient given the big question you have been dropping: Given the excess liquidity the Fed created and the distortion of risk perception the GSEs created, what evidence is there that there even is a regulation that would have prevented this crisis without making it worse or causing another one?

          Regarding the huge costs and inefficiencies home ownership has built into our economy you stand by the notion that it’s “a solid investment for most home owners measured over many decades.” If home ownership is a net cost, how could it be a solid investment over any time period? You say that renter’s pay property taxes, insurance, and are subject to risk? Are you sure, how? That was just three; you ignored the 5 other ways that home ownership absorbs more household income than merely paying rent. There is probably a social stigma against the effects of consuming less than one earns too, that is not an economic argument against saving. Confronting the evidence that our public policy goal of promoting home ownership was as bad as the market distortion itself is hardly a waste of time. To change course all we have to do is stop subsidizing it. 

          • valley person

            In a democracy, public policy and the market interact.  Spending on social programs or national parks, increasing or decreasing regulations, providing incentives….government does these things to address needs that the market is not meeting. By virtue of its existence, government “distorts” otherwise private markets. If the people want a completely free market in housing, they can get that through who they elect. If they want perpetually tight money, they can get that by electing advocates for this.

            The market responds to supply and demand, but also to policies that influence supply and demand. Since the government, through the Fed, regulates the supply of money, you can blame the Fed (government) for every market failure or hiccup. You can argue that an unfettered (or less fettered) market will “work better,” but better for whom exactly? If eliminating Fannie & Freddie, and tightening credit, resulted in a nation with 40% home ownership instead of 60%, would that be “better?” Would those left out for lack of affordable mortgages be better off by having been saved from a lifetime of monthly payments?

            Monetary policy cannot “form a bubble all by itself.” It can create conditions that facilitate a bubble. But it takes private investment capital flowing into a commodity to the point where it inflates the value beyond its intrinsic worth, leading to more capital rushing in to chase rising prices on the basis of the greater fool. In other words, it at the least takes monetary policy enticing investors.

            I’m not presenting “evidence” of the underwriting standards of community scale banks. But you yourself said they did not participate (much) in the securitization of subprime mortgages.  I imagine some small banks went crazy over issuing their own subprimes and held onto them. Big mistake. Others issued conventional mortgages, held them, and got dragged down by their customers losing their jobs and equity value in the wake of the crisis caused by the bigger players.

            And no, I did not refinance after 2008.

            The insurance on mortgages that could not be redeemed was an important part of the house of cards that was constructed. Without that insurance, its doubtful  that securitization would have been so appealing to investors who lacked the details on what was in the packages. They relied on the high bond rating (oops) and the insurance against loss (double oops) to conclude they had a reasonably safe investment.

            “By acknowledging that a market economy with the right monetary policy would not have bubbles…”

            You misunderstood me. Investment bubbles were part of capitalism long before there was such a thing as monetary policy. In my view, they are as natural to capitalism as any other feature of it.

            On regulation, its true I can’t point to a specific regulation, in place or not adopted, that if employed would have (for certain) prevented this madness. I have pointed to a number that could have helped. I can’t prove a counter factual, nor can anyone else, including yourself. You can’t prove that an entirely free market in housing combined with tight money would be a net good for society.  You may believe this, and you may present evidence in favor, but you can’t prove something that does not exist. 

            “Compare that to your acknowledgement that better monetary policy would have avoided the crisis entirely.”

            Did I say that? I don’t think I said that. TIGHTER monetary policy would probably have prevented over investment in housing. But I don’t agree that tighter monetary policy is inherently better monetary policy. It creates its own set of problems, including persistently high unemployment and productivity slack.

            “If home ownership is a net cost, how could it be a solid investment over any time period?”

            First, I didn’t say it was a net cost. You did. Second, even if it is a “net cost” compared to some other better investments not made, it was an investment in a place to live, not just a stock portfolio.

            Renters have added costs, like the cost of potentially being booted out on a few months notice.

          • D1.  You have dropped the alternate causality of Japan and Sweden, two huge residential real estate bubbles that happened on a such a grand scale without securitization. Their banks both large and small financed themselves the way the hundreds of small banks and credit unions in the US that have been failing and continue to fail did, by selling CDs rather than CDOs. 

            Regarding our banking crisis that continues to this day, “I’m not presenting “evidence” of the underwriting standards of community scale banks.” Indeed. 

            Regarding these small institutions, I “said they did not participate (much) in the securitization of subprime mortgages.” Remember I did this in the context of comparing them with banks that did and have been able to manage their risk. Japan and Sweden show that you don’t need securitization to cause a crisis, but securitization helps in restraining its effects. 

            “I imagine some small banks went crazy over issuing their own subprimes and held onto them.” Are you sure “some” is an appropriate word here? Already more than “some” have had to be seized by the FDIC. All are clinging to their TARP money for dear life. TARP was really for them, not the banks that were forced to take it. If our entire banking system looked like these community banks, we would look like Sweden in 1991. 

            You have already conceded how the GSEs distorted risk perception, making this statement irrelevant: “They relied on the high bond rating (oops) and the insurance against loss (double oops) to conclude they had a reasonably safe investment.” All of this is true but you left out why they did this. Remember, CDOs are used for all kinds of debt. Without a government guarantee on subprime consumer debt, investors subject credit card CDOs to a great deal of proprietary scrutiny. Investors buying tranches with the perception of a government guarantee do not. 

            “The insurance on mortgages that could not be redeemed was an important part of the house of cards that was constructed. Without that insurance, its doubtful  that securitization would have been so appealing to investors who lacked the details on what was in the packages.” Paying premiums on a CDS is not cheap. It was so cost prohibitive, subprime lenders could not use a CDS as a tool to boost their market share until they had the GSEs as an intermediary. 

            It is also important to remember that the underwriters of CDSs on CDOs have had no trouble paying when equity tranches have actually defaulted. This is why the banks who owned them have not been failing. 
            D2. You again dropped the placebo evidence from P5.D3. Who are you trying to kid when you acknowledge a monetary policy scenario where there would be no bubble and you drop D2, but still assert this: “Investment bubbles were part of capitalism long before there was such a thing as monetary policy. In my view, they are as natural to capitalism as any other feature of it”? Monetary policy predates capitalism. The abandonment of the manipulation of the money supply for short term gains is a relatively recent practice that is catching on. Indeed the surest way to publish in a peer reviewed economics journal is to model a time series analysis of Singapore’s M1 growth in the years before the 1998 Asian financial crisis and compare it to its neighbors. Long before the Bundesbank, there was just Switzerland and Hong Kong. Sweden has since followed Switzerland and Singapore has since followed Hong Kong. You keep ignoring this evidence. 

            D4. When it comes time to deal with the core of your argument, you adopt radical skepticism as a defense mechanism. You claim that you pointed out a number of regulations that would have helped. Did you? Every time you mentioned one with enough specificity to even discuss, I presented you with counter evidence why it would not work and you dropped that counter evidence every time, merely to go on restating your conclusion regarding underregulation. It is not hard to advocate pubic policy. People do it all the time. I suggested a regulation that would have prevented AIG from being unable to pay its obligations and compared that policy to that dangerous alternative of forming an under-capitalized GSE to hold monopoly over all derivative trades of every kind as a centralized counterparty. How hard was that?  All you have to do is make an argument, rather than restate your conclusion.

            Counterfactuals are proven by placebo evidence. I provided it in P5 and you have dropped it repeatedly. 

            D5. Once you acknowledge that monetary policy can prevent this crisis, it puts you in the  awkward position of saying that the crisis’ effects were not as bad as the effects of having a money supply that is bench-marked to GDP growth.  When you claim that a monetary policy that avoids financial crisis would be worse because “It creates its own set of problems, including persistently high unemployment and productivity slack” you should be able to support this assertion by identifying these negative effects in countries whose monetary policy has been protecting them from financial crisis for decades. Since these countries do better than we do, I can understand why you would want to ignore this fact. It seems you want a boom without a bust, a bubble that does not burst, monetary manipulation without inflation, regulators that are not captured, and politicians that govern in the general public’s’ interest. This is like Charlie Brown wanting Lucy not to remove the football. 

            D7. The question still remains. If home ownership is a net loss, how can it be a good investment? The best way to agree with me on whether or not home ownership is a net loss is to ignore the evidence that it is. I presented you with 8 ways home ownership absorbs middle class household cash flow. You dropped five of them but suggested renters pay taxes, insurance premiums, and are subject to risk. Now you have rightly dropped the first two and narrow your notion of renters’ risk to the observation that they can be evicted. This argument gets even weaker when we realize that home owners have just as many ways to be evicted, the most common of which is foreclosure which is the failure to pay their rent to a bank. 

            As you see your home ownership as a net gain position sinking faster than the Case Shiller index, you then fall back on a comparison of real estate market risk to stock portfolio market risk. We can verify this the same way we did in comparing the SP500 to blackjack. Pick the best 40 year window you can for home prices and compare them to the returns of the SP500 in the same time period. Of course, when avoiding a net loss, we don’t even have to assume the opportunity costs of never participating in the gains of the SP500. Simply saving that money in bank CDs would have done just fine. 

          • valley person

            Nor did Japan and Sweden have GSEs. So we both need a thesis for their bubbles that does not include our thesis for our bubble.

             “Japan and Sweden show that you don’t need securitization to cause a
            crisis, but securitization helps in restraining its effects. ”

            In our case securitization was a key factor in the particular house of cards we built. This is not just my opinion. It seems to be shared by all of your sources. And you ignore a pretty important historical point. Prior to securitization of subprime mortgages, we never has a national real estate housing bubble, even though we had low interest rates and GSEs for many years in the past.

            I assume you have heard of too big to fail. Well, the small banks are not too big to fail. They are allowed to fail because they don’t bring the system down around everyone’s heads, unlike the big banks. So comparing big and small bank failures in the abstract shows nothing.

            “You have already conceded how the GSEs distorted risk perception, making this statement irrelevant:”

            Assuming GSEs did distort the perception of risk on some securities, that doesn’t negate or diminish the role played by the bond raters or the role played by insurance. If all the investors needed was the perception that the government would somehow make bad loans 100% good, then they would not have required bond ratings or insurance. If they wanted risk free they had the choice of T-bills. They obviously knew there was some risk in buying what turned out to be crap.

            The US did not have a Federal Reserve until 1913. But we had numerous investment bubbles before then. With due respect, blaming all bubbles on monetary policy is pure Austrian school thinking. You and they are entitled to your opinion. I just don’t share it.

            By the way Eric, how do you explain the rise in gold prices the last 3 years? We have near zero interest rates and near zero inflation. What is driving all these yahoos to gold other than the thought there are more yahoos behind them?

            “You claim that you pointed out a number of regulations that would have helped. Did you? ”

            Yes, but for the sake of sanity I’m not going to re-hash these. Yes, you argued why this or that regulation would not work. Fine. Neither of us can prove our point because in fact the regulations either were not adopted or employed.

            Placebo evidence? You lost me there old chap. I’m not an ivy leaguer. In my public school world, proving a case that a regulation or set of them would have prevented an economic meltdown of historic proportions is not possible because there are too many variables. Its not as simple as “for want of a nail….”

             ” Once you acknowledge that monetary policy can prevent this crisis, it
            puts you in the  awkward position of saying that the crisis’ effects
            were not as bad as the effects of having a money supply that
            is bench-marked to GDP growth. ”

            Awkward? Maybe to you. To me, a rigid money supply is nothing more than classical economics. It works for thems that gots, but not for thems that ain’ts, to paraphrase Billie Holiday.

            A little inflation has proven to be a good thing over the years. Which probably  explains why our economy has performed better on every measure but one under democratic presidencies over the past 50 years compared with Republican ones.  GDP, household income, employment, stocks, you name it, the relatively looser monetary and fiscal policies under Democrats have beaten the tight money of Republicans.

            You say countries with tighter money “do better than we do.” Is that so? Across the board? Or are you just cherry picking a few? And how do you define better?

            Besides which, the US has some latitude to be looser on money than most countries because we are a reserve currency with the largest economy in the world. Sweden does not have this luxury, nor does Switzerland.

            But as I’ve told you before, give me Sweden’s social policies and spending and labor policies and health care and I’ll take their monetary policy to go with it. Being unemployed in Sweden is not like being unemployed here. 

            “It seems you want a boom without a bust”

            No Eric. What I want, and what I think public policy ought to strive for, is to round off the rough edges of the business cycle and capitalism. I don’t want either boom or bust. I want longer, more stable trends, not rapid growth taht runs big risks. I want intervention in the market when the market turns into a casino and threatens non players.

            “Simply saving that money in bank CDs would have done just fine. ”

            Right. But the bank won’t let you live there, and neither will dow jones or S&P. Owning a house is not equal to owning an equity. It has intrinsic values to the owner that a piece of paper (metaphorical paper that is) does not.

            So in calculating the net value of home ownership, you would have to include a lot of things you leave out. The ability to improve your garden soil by building tilth, which leads to better production and lower food bills. The ability to buy yourself rooftop solar collectors and lower your conventional energy consumption. The experience of planting a seedling and watching it became a tree. The ability to be a long term part of a community and neighborhood. The ability to hand something tangible to your kids that has memory attached to it.

            And then there is the reality that people don’t make binary choices between buying a house and NOT investing in the market, or renting an apartment AND investing in the market. In fact, I would bet that most market investors are also home owners, and most renters fail to invest. 

            The median price of a house in Portland was around $30,000 in 1978, when I moved here. Even after the big bust it is now around $230,000. That is about a 7% annual return compounded. And you can live in it, have pets, grow food, paint the walls any color you want….

             

             

             

          • D1 You had tried to mention that Japan did not have GSEs before, a rather silly thing to say given Japan’s well studied real estate crash. I pointed out to you that the Government Home Loan Corporation was one of the biggest GSEs ever. You dropped that point now you are claiming that Japan and Sweden did not have GSEs? In Sweden it was called the Bostadskreditaemnd which, having been fully privatized lives on as something of a mortgage insurance company with a portfolio of bad debt that has been indemnified by the government. 

            The important thing about Sweden and Japan is that they did not have securitization. When you are asserting a causal claim, the worst counter evidence possible is an alternate causality. Since these banks were able to sell CDs to investors even easier than our financial sector sold CDOs you cannot assert a causal claim to the bubble.

            You can explain the temporary loss of liquidity of mortgage CDOs by understanding how an OTC product became treated like a Treasury, but this is not inherent to securitization itself. This is why I brought up the fact that there are cheesy rating agency rubber stamps on all manner of CDOs with various insurance products available as well. From credit card debt to auto loans, investors don’t buy them without due diligence. Give a CDO of auto loans an implied government guarantee and watch the change in investor behavior. 

            Regarding too big to fail, banking failures come when all the banks fail together. You have dropped the point that it is our large institutions that are safe and our small institutions that are failing. If our entire banking system looked like these failing community banks things would be far worse. 

            “If they wanted risk free they had the choice of T-bills.” When T-bills’ yield is lower than the inflation rate, pension funds don’t have a choice, they have to take on more risk. A GSE guarantee gives them exactly what they are looking for. Knowing this, it was a public policy decision to distort this market to attract this capital that needed higher yield than Treasuries but needed security as well. “They obviously knew there was some risk in buying what turned out to be crap.” The fact that the CDO yields were higher shows that there were enough investors out there that did not count on the guarantee.  These CDOs turned out not to be such crap as soon as the government actually backed the GSEs just as the people who bought them thought it would. Investors ended up getting a higher yield and not suffering default. This never should have happened. 

            D2. Having dropped P5 over and over again you finally engage a bit, but not after a little radical skepticism about the ability to make public policy arguments. I cannot imagine you don’t know what placebo evidence is. Sweden, Switzerland, Singapore, and Hong Kong have developed securitization along with us. They have all the accouterments of modern finance, but they peg their money supply to their GDP growth to avoid asset class bubbles. Low and behold, they do indeed avoid asset class bubbles.  This dovetails fairly well with your acknowledging that the right monetary policy could have avoided our financial crisis entirely. 

            D3. This has you pivoting to a relatively new argument, that agrees easy money causes bubbles, but without easy money life would be worse. “You say countries with tighter money “do better than we do.” Is that so? Across the board? Or are you just cherry picking a few? And how do you define better?” First “tighter” is perhaps the wrong word. We had to tighten interest rates from 2005-8 to fight the inflation that came with the bubble. Fed policy in 1980-83 was even nastier. Loose money is followed by monetary tightening. These countries are doing better than we are by having our per capita GDP but without our boom and bust. This is a far cry from your assertion that pegging our M1 growth to GDP would produce a lower standard of living. So if you really want “longer, more stable trends, not rapid growth that runs big risks” this is how you get it. 

            The United States had conducted monetary policy long before the Federal Reserve Act. In 1913, the discount window was created and monetary policy was transferred to this new central bank. It is still possible to expand and contract the money supply outside the Fed through the US Dept. of Treasury. Thank God we don’t. The Austrian position is that the only way to have stable monetary policy is to peg the currency to a precious metal. I think that is needlessly archaic. The dominant school of economics today is Monetarism which also sees all bubbles as monetary phenomenon.

            The problem with the idea that a little inflation does some good, is how difficult it is to prevent a little inflation from becoming a lot of inflation. This tends to spiral until a Paul Volker eventually has to come along and give the economy chemotherapy to return us to price stability. Bill Clinton had loose fiscal policy? George W. Bush had tight fiscal policy? 

            The seigniorage of our currency is not something to abuse, and we have really pushed it this past decade. There are a lot of dollars that conveniently for us have disappeared into the world economy. We don’t want to create the conditions that will bring them all back.  

            D4. The core of your argument was dropped again.

            D6. I addressed the following line of argument earlier and you dropped it now it comes back: “If all the investors needed was the perception that the government would somehow make bad loans 100% good, then they would not have required bond ratings or insurance.” Bond rating agencies are a formal step created by ERISA and Basil I. Even Treasuries require a rating. The arbitrary way Basil I assigns capital requirements to different asset classes helps create the bond rating ritual. Regarding insurance, believe it or not there is actually a CDS market for US Sovereign debt. The problem with the CDS market connected to CDOs was that the premiums were too low. This is what is meant by risk distortion.

            D7. When you are confronted with the fact that home ownership is a net cost, and that after paying rent, middle class families could have stowed up substantial savings over the decades if they had forgone those 8 ways in which home owners pay more in rent, your response is “Right. But the bank won’t let you live there, and neither will dow jones or S&P.” Remember this is savings after they have paid for their housing costs. 

            So now you pivot to a notion of “net value.” Acknowledging the higher cost of home ownership, you want to now show what a great value folks get for spending more of their money. You can have a garden. Of course the monetary value of one’s time to grow one’s own vegetables undermines any claim to saving money. I cannot imagine you really think this is a material savings when compared to the price of a longer commute. The ability to buy a rooftop solar panel seems trivial when put onto a house that consumes more energy than an apartment. The ability to plant a tree in your yard. No other opportunities to plant a tree eh? You cannot be a member of a community in an apartment? Seems to me isolated picket fences are more alienating. There is plenty of opportunity to have pets in an apartment. Of course pets are themselves a huge expense, so living in a no pets apartment could be seen as another way of saving money. “The ability to hand something tangible to your kids that has memory attached to it.” Something tells me the kids would prefer liquid assets that exceed the value of the home than the need to sell a house and incur the transaction costs for an asset that brought such a low return. 

            This brings us to the rate of return. I’ll stipulate your 30k to 230k number. What was the risk free rate in 1978? It was 11.5%. A home buyer has to pay substantially more than that. That is to say you are buying a 7% yielding asset on margin while having to pay out probably 13%-14%. Yeah that’s a winner. Let’s compare the SP500’s rate of return in the same time period. $100 invested in 1978 becomes $2,288 by the end of 2008 an 11% return. So mommy and daddy could have put their savings from the high cost of home ownership into an index fund, and end up having a lot more to give their children in the end. 

            Remember I am talking about home ownership as a net cost. Another way of saying this is home ownership is an act of consumption not an act of investment. If having a garden and planting a tree have value to a home buyer, its value competes with other things that have value. Those other things must be foregone so as to afford more expensive housing costs.  

          • valley person

            In summary: Your thesis s that GSEs and “artificially low” interest rates CAUSED the housing bubble AND its collapse. Mine is that they were both contributing factors but not primary causes. You cite “placebo” examples, other banking systems that at least so far, have not resulted in investment bubbles. I cite history. The US had a myriad of pro housing policies, had GSEs, and had “artificially” low interest rates for decades prior to the housing bubble. What changed in the mid to late 1990s ante the bubble?

            In rough order:

            1) America (and Europe) de-industrialized as free trade took effect and
            China became a major provider of capital that had to be reinvested in
            the west

            2) Private financiers created new instruments that allowed securitization of subprime mortgages AND got deregulation OR managed to stave off new regulation of new instruments.

            3) The dot com bubble burst (was this also caused by the government?), we
            had a big terrorist attack, and the Fed responded by keeping interest
            rates low 

            4) Private financiers, led by Countrywide Financial, greatly increased subprime lending (not backed by GSEs) as housing prices started a rapid rise

            5) Fannie & Freddie, well into the bubble began investing in these instruments

            6) Private capital poured through the gates to snatch up securitized mortgages. Where else could/should it have gone given our de-industrialization?

            7) Alan Greenspan said no worries mates, the market will manage itself. And those subprimes are actually a good thing by the way.

            8) The Fed began to raise interest rates (presumably a good thing in your book), subprime mortgages began to fail, investment banks (not regulated by our commercial banking system) and heavily leveraged became illiquid, there was spillover into the commercial banking sector, capital markets seized up, and the government had to come to the rescue. The eocnomy fell into a deep hole, personal consumption collapsed, deepening the hole, and Keynes was dusted off.

            9) Free market fundamentalists immediately built a narrative that put the blame on not only government, but Barney Frank, who was not in power during the entire crisis. This is what is known as a tell.

            “The dominant school of economics today is Monetarism which also sees all bubbles as monetary phenomenon.”

            That dominant school is being challenged by reality. Monetarism, among other things, asserts that interest rates are the only lever that need be managed to have both full employment AND low inflation. Current times show this to be wrong, just like stagflation showed Keynes to be less than perfectly right.

            What both systems of thought can’t account for is the impact of deindustrailization as a consequence of free trade, because both systems were created in the context of a robust industrial economy. Economists thought, and still seem to think, that comparative advantage will lead to something more productive always replacing that which is lost, as your company title, “creative destruction” implies. Maybe in the very long run this is true. But as Keynes said, in the long run we are all dead. In the short run, a matter of at least 3 decades now, we have experienced a stagnant or declining middle class, with most ordinary people having to work every harder to maintain standards of living. We managed this for a while by sending spouses into the work force, which increased household income at the cost of a lot more working hours. But we played that string out once nearly all spouses were employed (often at crappy wages). Some (mostly on the left) think higher ed is the answer, but those kids in the park with $50-100K debt loads and few prospects have shown this path to be problematic. The free marketers want to go backward to go forward. Deregulate, eliminate the minimum wage, eliminate unions….the 1920s or 1880s were such a great decade after all. The left, including myself, are casting about for a forward direction. We like western Europe, but it too is de-industrializing and losing ground. We need a new Keynes, but one with a new theory based on observed reality.

            “So mommy and daddy could have put their savings from the high cost of
            home ownership into an index fund, and end up having a lot more to give
            their children in the end. ”

            13-14%? Mortgages in the late 70s were not that high. But even if they were mommy and daddy could have refinanced at lower rates by the mid 80s, and refinanced again at even lower rates in the 90s.

            A house is one of the only asset classes  (art being another) that provides multiple, tangible benefits while also appreciating in value.  Where did mommy and daddy live while their index fund grew? What schools did their kids attend? What relationships did they build with their neighbors? Did they eat fresh food from their own garden? You put this all down to “consumption?” Some of us call it a decent life.

            “Here son, I have this wonderful investment fund for you. You don’t have to do a damn thing other than leave it alone and dip into the interest now and then. Your mom and I are sorry you had to grow up in a crowded apartment and attend declining schools, but hey….you don’t ever need to do productive work anyway because your future is all being taken care of by Wall street. Best of luck.”

             

          • In an effort to restate your conclusions in rough order, you dropped nearly every point I made in my previous post. This has been a pattern, you find a counter-argument you cannot address or a set of facts that are too inconvenient to face, so you ignore them, but restate your conclusion anyway. I am going to call this new list RO1-8. 

            D1. By dropping D1, you have abandoned all supporting material for RO2, RO4, RO5, and RO6.

            D2. By dropping D2, you have abandoned all supporting material for RO7, RO8, and RO9. 

            D3. Our discussion about monetary policy has been the most interesting. It went from having no role, to being a mere “facilitator,” to being largely something we can agree upon when facilitation began to look more and more like causation. When it comes to regulatory policy, you embrace radical skepticism of our ability to make public policy arguments, but when it comes to monetary policy you admit a different monetary policy could have prevented this crisis. By dropping D2 you have rightly abandoned the unfruitful reasoning that merely pegging our M1 growth to GDP would be a ticket to poverty.

            D4. I have reminded you several times that you have dropped the core of your capital letters argument. What is so remarkable about your latest post is how peripheral regulatory policy is at all. I don’t blame you. I would be too embarrassed to be in a position to argue something like: it is the case that we cannot know anything about regulatory policy. Therefore underregulation was the cause of the crisis. So your last post abandons D4 by justifying loose monetary policy instead. It does so first by establishing its need in RO1, RO3, and various laments about deindustrialization. Then you show how the Fed popped the bubble when it had to start fighting inflation in RO8. When if comes to monetary policy, human knowledge is possible and, you can make arguments. When it comes to regulatory policy human knowledge is impossible and you cannot defend the capital letters argument. If you take a step back and compare your two approaches, you might realize that you are responding to the fact there is evidence for a monetary cause but no evidence for a regulatory cause. 

            D7. Let’s not forget that the question was if home ownership is a net cost or not. Regarding interest rates. I showed you the risk free rate in 1978. Borrowers do not pay less than the risk free rate; they pay a risk premium significantly above it. They would not have been able to refinance below 7% until this past decade, that is to say, they would be paying more in interest than their asset was growing in value until just a few years before they should have had the mortgage paid off. Every time they refinanced in the 80s and 90s, it restarted the amortization schedule; so little ever went to principal. That sounds like the typical middle class homeowner to me, that ends up passing a house to their children that still has a mortgage, and we are not even talking about how these refinances tap that house’s equity to purchase other things they “need.” If someone were to incur the added costs of home ownership because they “needed” a garden and they “needed” to plant a tree in their yard what other things do they “need”? The essence of investment is saving. One does not save by turning every potentially nice thing into a need to justify higher cost housing. 

            “A house is one of the only asset classes  (art being another) that provides multiple, tangible benefits while also appreciating in value.” You are ignoring the tangible benefits of the things that a higher yielding investment would be able to purchase had they not paid too much for housing for decades. You do not have to own a home to attend good schools, have relationships with your neighbors, or even eat fresh food, but you do have to fork out a lot of money over the years that renters do not, making it a net loss. Of course this is true of all excess consumption. In pursuit of the things they think they need, many Americans do not save for future contingencies. These future contingencies eventually find homeowners really needing the money that they should have saved. The notion that net debtors live a more decent life is a tough position to defend in moments like these.

          • valley person

            I chose to re-state because I became lost in your R2- D2 loop.

            ” It went from having no role, to being a mere “facilitator,” to being
            largely something we can agree upon when facilitation began to look more
            and more like causation.”

            Once again you extrapolate my argument to turn it into your own. I stop way before causation, at facilitation. If the facilitation had not coincided time wise, then there would have been nothing to discuss.

            “when it comes to monetary policy you admit a different monetary policy could have prevented this crisis.”

            “Could have” is the operative word. Just like improved regulations “could have” prevented the crisis. A lot of things “could have” prevented a bubble from forming, or intervened in its formation before it became dangerous, or prevented financiers from turning mortgages into a casino. Could have is not Would have.

            “By dropping D2 you have rightly abandoned the unfruitful reasoning that
            merely pegging our M1 growth to GDP would be a ticket to poverty.”

            I don’t think I said ticket to poverty. But I will say that further restricting the one tool left in the monetarists tool kit, especially at a time of persistent high unemployment, lack of private sector demand, high savings rates, and so forth is a ticket for continued stagnation.

             “I would be too embarrassed to be in a position to argue something like:
            it is the case that we cannot know anything about regulatory policy.
            Therefore underregulation was the cause of the crisis.”

            So would I, so I don’t make that argument.  I make the argument that we know a lot about regulatory policy, and we know what happened in the absence of regulations on new financial instruments, but we can’t be certain that adopting and enforcing a particular regulation would have prevented the particular occurrence.   I  would be too embarrassed to make a “certainty” argument about something as complex as the national economy. You apparently don’t share this hesitation.

            I will argue that under-regulation likely contributed to the crisis, for reasons stated multiple times and contained in most of your own cited sources.

            “When if comes to monetary policy, human knowledge is possible and, you
            can make arguments. When it comes to regulatory policy human knowledge
            is impossible…”

            Substitute PERFECT HUMAN KNOWLEDGE for both cases, and you are closer to my argument. If Greenspan had had PERFECT knowledge that raising interest rates when he did, at the rate he did, would not only pop a bubble, but that this popping would bring down the entire financial system and usher in the worst recession in 70 years, he would have done something else. If anyone has any PERFECT knowledge of the consequences of any regulation or policy, I’d like to meet them.

            “Let’s not forget that the question was if home ownership is a net cost or not.”

            Let’s not forget that is the question YOU are focused on. The question I’ve been focused on is whether government policies to encourage home ownership are a net good thing for our nation.

            “Every time they refinanced in the 80s and 90s, it restarted the amortization schedule”

            Not necessarily. Refinancing at a lower rate can include a shorter payback period, taking advantage of the equity built plus the lower interest rate. You should also be aware that back in the high interest years, many people, myself included, bought homes on contract from sellers, bypassing lenders and getting much more favorable interest rates.

            “but you do have to fork out a lot of money over the years that renters do not”

            Perhaps. But renters also fork over a lot of money that homeowners do not. Moving is expensive. Deposits are expensive. Changing schools can be expensive and disruptive of learning. Therapy for kids who have no friends or pets and moved every 2 years is expensive.

            If you did a statistical analysis on the net wealth of renters versus homeowners, which group do you think would come out ahead?

             “The notion that net debtors live a more decent life is a tough position to defend in moments like these. ”

            Well, its easy to make an argument against housing as an investment in moments like these. Its easy to dismiss the value of owning (payments) over renting at a historical moment when values are declining. Those arguing for gold as an investment right now look like geniuses. Those who made that argument in 1980 look pretty dumb. Those who like stocks looked pretty smart in the 90s, very dumb at the end of the Bush years, and smart again after the first 2 years of Obama. Commercial real estate investors looked pretty dumb in the late 80s.

            Smart or dumb then, appears to be largely a matter of timing.  

             

          • You were restating premiseless conclusions long before I offered up a list of 9 things you had ignored repeatedly. It worked like a charm prompting you to engage them somewhat rather than pretend they were not there. When your tepid responses were met by more facts, you preceded to ignore them again. You offered up a list things that we disagreed on. I followed your numbers. The use of notation would help anyone seeking clarity. It is not that the use of notation is confusing that you restate your conclusions. It is that time and again when presented with facts that undermine your argument, you drop the point, only to restate your conclusion again a couple posts later, pretending you had a response to that stubborn fact when you did not. 

            You initially said in no uncertain terms that deregulation was the cause of the crisis. You agreed with Stiglitz it was caused by deregulation. You provided a link that did not support your conclusion. When I pointed that out, you had two responces: direct my questions to Stiglitz and you made a pivot to the failure to regulate as the cause of the crisis. This brought us the capital letters argument: “FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED YOU GUYS TO CREATE THIS MESS.” I don’t see any epistemic humility in that assertion. When I tried to engage this argument, suddenly knowledge is not possible. You don’t need to offer even an explanandum as to how a particular regulation would have changed anything. Simply providing the name of Brooksley Born was enough. When I give you a rational account as to why her proposal would have made our crisis worse it would require perfect human knowledge to draw such an inference. This puts you in the position of asserting that it is the case that “FAILURE TO REGULATE THE NEW FINANCIAL INSTRUMENTS ALLOWED YOU GUYS TO CREATE THIS MESS” but it is also the case that we cannot know if the regulations would have made things better or worse. 

            You were all over the map on monetary policy. You went from thinking interest rates are caused by inflation to actually being able to describe in your own words how monetary policy affects the behavior of borrowers and lenders. That is to say, you were able to do something you could never do when talking about regulatory policy: you articulated an explanandum. You did not need perfect human knowledge to conclude with full confidence that if interest rates were higher we would not have had this crisis. You did not say “could” or “might.” This is what you said “we wouldn’t be having this discussion.” I agree. You actually did it again in the post I am responding to here. Take a look at this locution: “I stop way before causation, at facilitation. If the facilitation had not coincided time wise, then there would have been nothing to discuss.” You seem to be hiding behind a synonymous term for a causal agent, willing to say in no uncertain terms that if we remove this “facilitation” then the outcome we are discussing “wouldn’t” even occur, not “may”, “might”, or “could”, you say “wouldn’t.” Again I agree. 

            This changed your direction to defending the policies that created the bubble. The first argument you made for why promoting home ownership was good for society was its role as an investment for the middle class when you said home ownership has been “the most solid investment for most Americans.” You then identified the role of subprime lending as an effort to include more Americans in this wealth creation: “We also had a lot of red lining and other discriminatory practices that left a big segment of Americans out. Over time we expanded programs to help more people get a slice of the pie.” If we have in fact been promoting a more costly form of living, that yields a negative rate of return, then this claim is demonstrably false. I mentioned other externalities on society like sprawl and the higher cost of delivering public services. You dropped them and tried to defend the return on investment myth. 

            Regarding refinancing, every time you refinance it starts the amortization schedule over again. Dropping from a 30 year term to a 15 year term will still reset amortization too. It will also increase the size of the monthly payments. When rates go down people refinance to lower their monthly payments. They do not incur an origination fee and pay for an assessment when simply writing a bigger check will do. A builder is not going to charge a home buyer less than the risk free rate on his loan. The risk free rate remained higher than 7% until just a decade ago; so for most of the duration of the mortgage the cost of renting money exceeded the home’s appreciation in price. That is not a recipe for investment success. 

            Regarding the cash flow destruction that home ownership has wrought on the middle class, you say “perhaps” but then try and meekly find something renters pay that home owners don’t. “Moving is expensive.” Homeowners move too, but their transaction costs are far higher. The problem with moving is that NOT moving is even more expensive. Forgoing a promotion or limiting one’s job search to the city one owns a home in presents a huge opportunity cost and a seriously negative externality in making our national labor market less flexible. Changing jobs within the same city leads to longer commutes. “Deposits are expensive” compared to what down payments? Paying for an assessment? Paying insurance? Moving harms children. If I remember correctly, the effects are limited to introverted and neurotic adolescents with no affect on either young children or late teens. This really narrows it down. The few people with this complication can choose not to move to another neighborhood or another city, but adolescent children whose home owning parents let a job opportunity go by when they were younger because their home glued them in place, lose out in different ways. 

            “If you did a statistical analysis on the net wealth of renters versus homeowners, which group do you think would come out ahead?” Clearly the renters, if you control for income. That is to say, a $36k a year income earner will have spent less on housing over the same time period than a person of the same income who bought a home.

            The issue about home ownership has less to do with timing than it does with costs and indebtedness. Let us not forget our 1978 to 2008 three decade comparison actually made housing look better because it included the bubble that still has a long way to deflate. For stocks that same time period included five bear markets. Timing did not matter when we compared the SP500 to blackjack either. We had the stock investing brother invest his money the day before the 1929 bear market began. Now he would own hundreds of millions of dollars. The issue is about paying too much for housing regardless of the time period and getting into debt to do it. 

              

          • valley person

            Well, I seem to have lost a lengthy reply.  I lack the patience to recreate it, so will summarize.

            On regulation, I refer you to a Frontline interview with Brooksly Born. She lays out the case for why derrivatives (to name just one financial instrument) should have been regulated. And she says how the financial industry (you guys) fought this off. I’ll let her make my argument for me:

            https://www.pbs.org/wgbh/pages/frontline/warning/interviews/born.html

            On my perspective of the role of monetary policy, specifically low interest rates. I don’t know what the optimal short term rate should have been. I don’t know what rate might have prevented over investment in housing leading to the bubble without crippling the housing industry. Logic says that at some level rates would be high enough to discourage buyers and hence investors.

            On owning versus renting. The net worth of home owning households is about 40 times that of renter households, even though the number of home owners is only 2 times that of renters. And, the largest part of net worth for most households is their home equity. This suggests there is a pretty strong relationship between owning a house and building wealth. It could be that people only buy a house if they first have wealth, but I don’t think so. So your case against housing as investment, based primarily on positing alternative investment performance, is flawed by reality. If you are right, and if people are utility maximizers, then we should have more rich renters than rich home owners, even accounting for government policy that favors home owners. But we don’t.

            Beyond that Eric, people “maximize utility” in housing by considering a whole lot of issues. For the most part (my experience) people seem to choose a geographic and community location based more on family ties, friendships, scenery, schools, etc than they do based on a job or promotion. You may travel in different circles than I do. You couldn’t pay me enough to move to Omaha or Houston.

            In any case, index funds were only first available in the mid 1970s and had no track record. So I doubt many people were sitting around trying to decide between investing their $6K in an index fund or using it as down payment on a house. Don’t you agree at least on that point?

          • Beyond the obvious problems of relying on a bias source, something you know I do not do, by letting this link make your argument for you what you are doing is letting the PBS interviewer’s softball questions address those 6 reasons I gave you why everybody rejected her proposal, by everybody I mean even the many very hard corps regulators at the SEC. 

            The only argument against her proposal that I gave to you that she addressed was regime uncertainty. The problem with outsourcing your arguments to her is that what she said was not true and is actually verifiable because that link actually provides a link to her original proposal. Take a look Born’s answer and then compare it to the original document. Her approach to regime uncertainty got even worse during the President’s Working Group discussions. There is a lot of literature out there, the most detailed comes from that time period. Rather than just google, do what I do, use Multnomah County Library’s electronic research function from their web site to get archived information, kind of like what folks used to do with microfilm but you can do it all from home now. You will need a library account and pass word but I assume you have one. In your link, she addressed one objection that I did not bring up because I know that Basil should make it moot, but that was the way in which bank customers that need OTC derivatives will simply go overseas to get them. When we have a sound regulatory proposal we should be able to include it in our Basil talks. Having said that, AIG’s unit that issued all its CDS trades was based in London and outside US regulatory jurisdiction. Probably the most embarrassing thing for you, in using her as a source, has got to be her description of LTCM. Before I give you the details, consider this first. She made her proposal before LTCM failed. LTCM failed during the PWG discussions. It has got to seem somewhat incredulous to the casual observer that this event hurt her proposal rather than help it. 

            Now the details, LTCM did not lose money from its derivative trades. That is a fact. LTCM did old fashioned leveraged bond market arbitrage. Its only innovation was a unique trading algorithm. Everything that LTCM did that lost money was heavily regulated. LTCM’s failure on these trades would have presented more systemic risk in 1998 than AIG presented in 2008 if all it had were its bond trades. So why didn’t it need a bailout? Because its positions were hedged with interest rate swaps, that is to say unregulated OTC derivatives reduced systemic risk, they did not increase it. One of course might want to ask the question, why couldn’t those heavy handed regulations of its bond trades do the same? 

            If you don’t believe me on these facts, there is plenty of objective literature on the subject. As you know, I provide a different analysis on some things than you have heard before, but you know you can rely on me to present facts accurately. Again check this out yourself and then read again how Brooksley Born relays events. 

            If you are disappointed that this ambitious lady turns out not to be such an angel, I don’t think you should be. We both agree that Bankers, Politicians, and Regulators are all human and all greedy. She was lobbied too just like everybody else. There were stakeholders in her proposal just like there were stakeholders in the Bank Act of 1966 that nearly tore down our entire banking system. After making a big power grab, trying to move into the SEC’s lane, her hare brained scheme of creating a giant GSE to act as a centralized intermediary for swap trades was soundly rejected by even the most ardent supporters of financial sector regulation. Years after she was soundly defeated, she has relished the mythology of the Casandra. She is enjoying life on the speaking circuit. This mythology of course takes a great deal of fudging of the facts to maintain. Just looking at how she describes LTCM is the tip of the iceberg, compare what she said in her interview and compare it with her proposal document and the reporting on the PWG in 1998. 

            And let’s not forget we are just talking about AIG here. AIG was not even the dominant player in the CDS market. Lots of other institutions had CDS liability and had no trouble paying up. AIG is famous now because it could not. I have no dogmatic objection to regulation. I have been convinced by arguments that CDS sellers should be mandated to purchase reinsurance in the same way property insurers do to be able to pay out after major earthquakes and hurricanes. This is a perfectly sensible regulatory move that would have prevented AIG from defaulting, however, we would still have had our real estate bubble and its financial crisis. That is why I have said before CDSs were peripheral to the crisis. It is not because of CDSs that our small banks and credit unions are dropping like flies and clinging on to their TARP money for dear life. Even if Brooksley Born had made a proposal that would have improved the CDS market rather than made it worse, it would not help your capital letters argument because CDSs played no causal role in the crisis. 

            On monetary policy we have unambiguously reached agreement: “I don’t know what the optimal short term rate should have been. I don’t know what rate might have prevented over investment in housing leading to the bubble without crippling the housing industry. Logic says that at some level rates would be high enough to discourage buyers and hence investors.” I could have said the same thing. Central bankers in Singapore have no idea what interest rates SHOULD be, all they have to do is peg M1 growth to GDP growth and the savings rate determines what interest rates should be. 

            Once it is understood that home ownership is a net cost, one cannot then try and argue that this cost causes wealth by showing a correlation between affluence and home ownership. Can we not show the same correlation between affluence and any other cost? Let’s run a study and see if flying first class to Hawaii is correlated with high net worth. That would be no way to show that expensive vacations build middle class wealth. 

            Our highly leveraged, low savings rate economy has people maximizing their utility with over consumption in many ways. Home ownership as a net cost is just another element of this. With our common understanding of monetary policy we both know why this is the case. The incentives for saving have been reduced and the incentives for borrowing to consume more have been increased. 

            In 1978 the Vanguard 500 was available and was the talk of the financial planning world then and now. It’s track record was of course the index itself which has a 1926 inception date. When calculating whether home ownership is a net cost or not, we don’t need to assume stock market gain type opportunity costs. Like I said before, saving the money in a bank would have been just fine. The renter comes out ahead by negating the costs of home ownership. 

          • valley person

            ” Take a look Born’s answer and then compare it to the original document.”

            I don’t have the time or the inclination. Her argument is supported by others by the way. Now you can say they are all wrong as well. Fine.

            “If you are disappointed that this ambitious lady turns out not to be such an angel…”

            I didn’t put her on a pedestal, so you shouldn’t feel obligated to knock her off of one. She and her team made a case for regulating derivatives. They lost the argument after a lot of lobbying. System crashed and burned in part due to derrivatives. That’s the story line I accept.

            “This is a perfectly sensible regulatory move that would have prevented
            AIG from defaulting, however, we would still have had our real estate
            bubble and its financial crisis.”

            Well, this is the core of our disagreement isn’t it? You say we would have had the bubble due to 2 factors:

            1) artificially own interest rates due to monetary policy
            2) The role GSEs played in reducing perception of risk

            I acknowledge both of these as contributing factors, but believe other, private market factors were more important:

            3) Absence of regulation (shorthand for dereg, lack of new regs, failure to use regs available)
            4) Creation of new financial instruments that decoupled mortgage lending from its historic norm (long term fixed interest with 20% down, direct lender-borrower relationship)
            5) Securitization and Derrivatives

            You have ably made your case. You don’t buy the case of the other side. I don’t buy your case for reasons stated and re-stated. I say we would not have had the bubble or its aftermath had the financial industry not engaged in 3-5. You say 3-5 had little or no bearing. You go to great lengths to dispute Borne, Krugman, Stiegletz, and some of your own sources who make the case for 3-5. I don’t have the time or inclination to do investigative reporting beyond what I have done.

            “On monetary policy we have unambiguously reached agreement:”

            I don’t think so. If I agreed with you I would have to agree that the optimal interest rate is the Singapore model, end of story. I don;t agree with that for reasons stated. If a society is going to manage BOTH inflation AND unemployment within acceptable ranges, then it cannot simply put monetary policy on automatic pilot.

             “Once it is understood that home ownership is a net cost”

            Its not understood at all. A 7% return over 30 years is not a net cost. It may not be a maximum rate of return compared with another investment. But it clearly is not a net cost.

             ” The incentives for saving have been reduced and the incentives for borrowing to consume more have been increased. ”

            We agree on this point. However, one wonders how a high savings rate US economy would function. Where would all this savings go? Who would “consume,” given that the rest of the world exports to us? Japan’s bubble formed largely due to so much savings having nowhere productive to go. 

            “The renter comes out ahead by negating the costs of home ownership. ”

            Only if “ahead” is limited to net worth. And only assuming Americans have not been utility maximizers, broadly defined. 

          • The most you have done with Brooksley Born just now is bring her up to the level of how you used Joseph Stiglitz: here is a link, I agree with what they say. Now that it turns out this link to an interview with Born, an even less credible authority for a guy that likes to commit the logical fallacy of the appeal to authority, does not even support your conclusion. It turns out she’s only dealing with CDSs. Do we go back to “ask Born” or can you use facts to articulate an explanandum to support an argument?

            I gave you six reasons why all her contemporaries rejected her proposal. She only addressed one of them. When presented with evidence that her proposal would not only make the collapse of LTCM worse, it would have made the effects of the 2008 collapse of our housing bubble worse too. Is your response more of a “so what” approach to the dangers of regulatory induced moral hazard? I gave you a sensible solution of mandating the purchase of reinsurance. This solution was rightly included in Dodd Frank. The fact that Born’s proposal was rejected again last year should tell you something. 

            Then there is the problem that even if her proposal solved what it intended to solve without making matters worse, it would only have dealt with AIG. You dropped the point that had AIG been able to pay its counterparties, small banks and credit unions would still need TARP money, they would still be clinging on to it for dear life, they would still be failing by the hundreds, and we would still have a recession. AIG was taken down by the housing bubble, but it did not cause it. In your link, Born did not even claim that it did. You also dropped the point that the other CDS dealers were able to pay their counterparties, a fact that shows how this product minimized the effects of our housing bubble, and advantage that neither Sweden nor Japan had. 

            After having been so burned by misrepresenting Tett, Morgensen, and Mclean, are you now suggesting that they have claimed that the financial crisis would have been prevented if Born’s proposal was adopted? You have a copy of Morgensen’s book, why don’t you tell me why the name Brooksley Born and her proposal never appears in it. Of those four books, Morgensen’s was the one focused most like a laser on making a clear causal assertion for the crisis. Neither Tett nor Sorkin ever mention her either. Mclean who sought to report on every aspect of the crisis both cause and effect would be your best hope to assert causality for not having adopted Born’s proposal. Instead she explains why it was rejected. In fact it is Mclean that first pointed out to me how the LTCM collapse made Born’s case worse, a very counter intuitive fact to understand available to curious people read books like hers in an attempt to find understanding. But again I don’t need their authority. I just need their facts. In that PBS interview, Born contradicts Mclean. Indeed Born makes several claims that even contradict the original document of her proposal. You don’t have the time to be bothered with such inconvenient facts? You have already devoted some time to our conversation. You cannot devote more time to vetting the facts?

            The great irony here is that you have tried to paint me as ideological, but the facts have forced you to accept the causal role of the GSEs and monetary policy, but you still hold out for “other, private market factors were more important” when you have neither facts nor explanandums to support your assertion. Time and time again you have dropped the evidence that I provide you, only to reassert your conclusion because as you once said: “That’s my story and I’m sticking to it.”

            This irony becomes even more salient when we look at what you just said about monetary policy. You have acknowledged that a change in monetary policy “would” have changed the outcome. You have dropped my point that countries that that peg their M1 growth to GDP have a lower unemployment rate than we do, but you just said again this policy that would avoid asset class bubbles is not worth it because “If a society is going to manage BOTH inflation AND unemployment within acceptable ranges, then it cannot simply put monetary policy on automatic pilot” How could any thinking person say that when there is so much evidence that this policy produces less unemployment and no inflation. You have already acknowledged what this monetary policy “would” have prevented our housing bubble, having Sweden, Switzerland, Singapore, and Hong Kong’s low unemployment and price stability seems a small price to pay.

            An asset that yields only a 7% rate of return whose purchase requires a loan that well exceeds 7% is a net cost. Like a mortgage broker and a real estate agent, you sell one side of the ledger and ignore the other. In addition to ignoring the transaction cost paid to the agent and the origination fees paid to the brokers, you are ignoring all 8 of the ways homeowners pay more in rent than renters. 

            “Where would all this savings go?” Glad you asked. We have already gone over how excess liquidity reduces the returns on all the low risk investments down too far for pension funds to meet their obligations. If interest rates are proportional to savings rates, investors are able to finance projects appropriate to their risk tolerance. It will not matter if we have a high savings rate economy or a low one. Our investment will reflect our behavior. People do not save because they have no desire to consume; they save because they have more demand for an even greater amount of goods in the future that exceeds their demand for goods now. Such an economy produces more capital goods than consumption goods. A high consumption economy with low savings is not necessarily bad if it has high interest rates. It has a higher demand for goods now than in the future and its coresponding interest rates will allow those fewer people who save to get a return on their investments without taking on too much risk, allowing for the production of more consumption goods than capital goods. This is modeled by the Production Possibilities Frontier. Recessions are ultimately sudden corrections of an economy’s position on the PPF curve. You will find this in any Economics 101 text book.

            “Japan’s bubble formed largely due to so much savings having nowhere productive to go” Are you sure this is caused by savings? Japanese savers have profited handsomely from their investments abroad. It is the way their domestic investment was routed into the grand scheme of Japan Inc. that makes the Japanese case so sad. Japan’s real estate bubble is the most tragic thing in modern economic history. It would be hard to create excess liquidity in a high savings rate economy. It would have to be intentional, and it was. First, let’s remember how high their savings rate has actually been: 15% – not exactly asceticism. Aside from a brief savings bulge in the mid 70s, 15% has remained a constant. Until our monetary policy got aggressively expansionary our savings rate huddled just under 10%. Our savings rate was lower than theirs even in the early post war period, but it was the huge difference in post war Japanese monetary policy and a rather Byzantine domestic financial architecture that formed the most epic real estate bubble ever known. Japan manipulated its money supply to keep its currency artificially low to promote exports. This involved not just open market operations like our FOMC, but an intentional regulatory regime that limited retail investors’ options. The fact that they were doing most of these savings at their post office should be a red flag to any analyst. Imagine a US economy where Microsoft and Intel had to fund their growth from the Department of Commerce’s coordination of bank loans rather than selling equity to retail brokerage customers. Since 1989, Japan’s household savings rate has remained around 15% but its national economy has transformed into a debtor nation. After paving every road over many times, and connecting every small rural hamlet with broad band internet, they have gone to no national debt to the biggest debt to GDP ratio in the developed world: 225% – worse than Greece. It is a sad story all around. 

            It is hard to imagine many middle class home owners swamped in debt, that could make sense of what your broad definition of being “ahead” is. Every advantage of home ownership that you tried to offer could be enjoyed by a renter except having a garden. Even the tiny fraction of people who actually grow their own vegetables would gladly give up their garden to be debt free. Even organically grown produce at a farmers market is not that expensive.

  • valley person

    New thread.

    Here is another “biased source” I like to rely on. Its called the findings of the Financial Crisis Inquiry Commission, which if I recall Brooksley Born was part of.

    They concluded that among other things, the SEC failed to use its authority to oversee the investment banks. SEC could have set higher capital requirements and stopped some risky investment practices. The NY Fed could have stopped Citi Group from increasing its risky holdings even as the collapse had started. Financial managers too excessive risks because the upside was higher than the downside. (See Raghuman Rajan’s paper for a good discussion of this issue). The Commission also noted:

    “A combination of excessive borrowing, risky investments, and
    lack of transparency put the financial system on a collision course with
    crisis.”
    “There was a systemic breakdown in accountability and ethics.”
    “Collapsing mortgage-lending standards and the mortgage
    securitization pipeline lit and spread the flame of contagion and
    crisis.”
    “Over-the-counter derivatives contributed significantly to this crisis…”
    “The failures of credit rating agencies were essential cogs in the wheel of financial destruction…”

    The Fed had the power to “stem the flow of toxic mortgages.” it chose not to.

    Financial institutions originated and sold securities they failed to examine and/or knew were defective

    40 to 1 leverage rations meant that a 3% drop in asset value would wipe entire, very large investment firms, including ALL 5 of our major investment banks.

    So my particular thesis is backed by the conclusions of the commission that dove into all the details. Of course, they could be wrong too.

    Born’s esteemed colleagues rejected her advice, and some of them have admitted they erred. CDS’s became a critical aspect of the failure. Her proposal anticipated costly failures like AIG.

    I’m not arguing with your “facts” Eric. I’m arguing with the conclusions you draw from the facts. I believe your conclusions are biased by your politics and your profession. A catastrophic financial collapse has to be government’s fault because markets can’t possibly fail that badly right? Those of us who don’t worship at the free market alter, and who don’t engage in day trading  have a different bias and draw different conclusions from the available facts.

    And no, I don’t have the time or inclination to dig up yet more facts. But I will point you to Rajan’s paper, which was presented prior to the collapse but well into the bubble. He spent a lot of time detailing the potentially dangerous role of CDs’s, and how these were intertwined with excessive risk.

    Japan has a big public debt, true. But it built that debt in large part to counter balance the huge private savings. They needed additional consumption or they were going to drown in capital.  Hard for a capitalist to accept, but not inconsistent with what Keynes wrote about in the paradox of thrift.

    Those middle class homeowners were not swamped in debt until quite recently. And even now, as I pointed out, homeowners have far more net worth than non homeowners. You confuse individual theoretical investment options with the real world facts.

    • A biased source indeed. The commission was created for the purpose of advocating for the passage of Dodd Frank. The six members who were appointed by Democrats wrote their own findings and used their majority to approve the report to completely bypass the Republican appointees. So your response to my observation that you seem to be driven to ideological conclusions is to quote from an ideological document? The Republican minority also had a report. I don’t even need to use it to construct my arguments. I carefully select credible sources. It has got to concern you somewhat that I can get my information from the likes of Gretchen Morgensen, but you have to now quote from a report that explicitly downplays the role of the GSEs. If the only thing you knew about the American financial sector was from reading this report, you would never have guessed that Fannie Mae was the largest financial company in the world before 2008, and that it had complete dominance of both the mortgage market and American housing policy. Fannie Mae is a powerful lobbying force in American politics even today. This wholly discredited report reads like it was written by GSE lobbyists. That of course served its purpose. Dodd Frank left the GSEs untouched. 

      Ironically, this biased report did not even endorse Born’s old proposal to form a giant exchange for all OTC trades where a new GSE would act as an intermediary. So far her proposal has been core to your argument and even this discredited report does not support your assertion that if we adopted her proposal there would have been no financial crisis. 

      Another great irony is that the report identifies a series of ways that regulators could have raised lending standards. There is a rather obvious problem with this, the thrust of public policy at the time was to lower lending standards. Wells Fargo was at odds with regulators for being such tight wads with their money. Imagine that, a report that ignores the role the GSEs played in subsidizing lower lending standards laments the fact we had lower lending standards. 

      It’s funny you should mention Raghuram Rajan. He was the one who convinced me of the need to mandate reinsurance to CDS issuers. This is a sensible regulation, and I have no ideological objection to such things. This does not help you with your argument. We had a residential real estate bubble that has saddled our small banks and credit unions with bad debt. Whether or not AIG was able to pony up to its counterparties is entirely peripheral to that list of bank failures I gave you. 

      On Japan, it is a little strange to read you using Keynes to analyse Japan’s problems. You have already mentioned how Keynes has been long since discarded, and wow what a case study Japan has provided for why spurts of sugar high government spending do not catalyze sustained economic growth. I recall your longing for a new Keynes. That is to say, you long for a new theory of a free lunch. 

      Middle class homeowners were not swamped in debt recently. They were swamped in debt the moment they signed their mortgage papers. You did not point out that home ownership contributed to higher net worth. That people with higher net worth consume more is to be expected. Since home ownership is an act of consumption not an act of investment it correlates strongly with all other forms of consumption like trips to Hawaii. 

      We looked at real world facts to show how home ownership was a net cost. There was nothing theoretical about that 7% asset price growth being lower than the compound interest rate paid to obtain it. There is nothing theoretical about the need to pay for homeowner’s insurance, property taxes, higher energy costs, higher moving costs, longer commutes, and probably the worst thing of all for home owners: maintenance costs. 

      • valley person

        You selectively get your information from Mortgensen and  ignore her words, which I quoted at length, that contradict your thesis.

        Here is the heading of a book review on her work from USA today:

        “The American dream of homeownership morphed into a national nightmare
        thanks to greedy bankers, greedy legislators, greedy business leaders,
        greedy rating agencies and 98-pound-weakling regulators. Reckless Endangerment names names.”

        Its true she fingered Fannie and Freddie as key culprits. But she equally went after you guys, meaning the financial industry:

        “They reserve special scorn for the Wall Street
        bankers who they say ignored numerous signs of wrongdoing and kept the
        mortgage machine moving: “Their avarice would finally, and forcefully,
        demonstrate how a noble idea like homeownership could be corrupted into
        something that so poisoned the global economy that it was left in a
        semi-vegetative state.”

        “…even this discredited report does not support your assertion that if
        we adopted her proposal there would have been no financial crisis. ”

        Since I made no such assertion, what is your point? My assertion was that we know that NOT adopting her recommendation ended in the crisis. We don’t know the counter factual. How many times do I have to repeat that for you?

        “This does not help you with your argument. ”

        Rajan’s analysis backs my argument that unregulated new financial instruments increased systemic risk. He also supports your argument that monetary policy was a primary factor in incentivizing the bubble. We can both use him selectively or accept him at 100%, just like with Morgensen.

        “what a case study Japan has provided for why spurts of sugar high government spending do not catalyze sustained economic growth.”

        I don’t think that was ever Keynes argument, and it isn’t the argument of neo-Keynes economists like Krugman. The argument for counter cyclical government spending is to lessen the depth and length of downturns by propping up aggregate demand when there is lots of unused capacity. Japan’s deficit spending probably amplished this, as did Obama’s stimulus. But at the end of the day a normal private sector led GDP growth rate has to save the day. In Japan’s case, certain mitigating factors like the oldest population on earth, probably prevent getting back to “normal’ growth.

        “That is to say, you long for a new theory of a free lunch. ”

        That may be your view of my view. But my actual view is that by a “new Keynes,” what I’m looking for is an economic theorist who can come up with something that explains post industrial modern economies and a much more integrated financial and world market, with useful ideas for how to sustain and better distribute benefits and reduce systemic risks. What your side has offered is going backwards to “classical” low intervention economics, which failed miserably in 1929 and again in 2007. My side has offered the welfare/regulatory state as a buffer to capitalism, which is not sustainable if all the good jobs are shipped overseas. We need some new thinking or we will stay stuck arguing while the Titanic sinks.

        “You did not point out that home ownership contributed to higher net worth.”

        No, but it is correlated with net worth to such a high level that one can’t help but think they are closely linked. And since most households buy homes BEFORE they have much in the way of other assets, its hard to conclude home ownership is a barrier to asset accumulation, though you manage to do so.
         
        “There is nothing theoretical about the need to pay for homeowner’s
        insurance, property taxes, higher energy costs, higher moving costs,
        longer commutes, and probably the worst thing of all for home owners:
        maintenance costs. ”

        And there is nothing theoretical about homeowners having far far more total wealth, even aside from their homes, than non homeowners. What is theoretical is positing how much better off they would all be had they made other choices. And frankly its a bit presumptive of you to think you know what other people’s maximum utility is. I at least accept that they made their choices with eyes wide open.

        • Did I really selectively get my information from Morgensen? Let’s remember where we’ve been. I have used her as a source for facts to construct my own arguments. I don’t need to commit the logical fallacy of appealing to her authority. You however selectively picked quotes where she appeared to be saying something bad about private companies. She was indeed saying something bad about private companies, all things that I agree with. It is a bad thing to have mortgage originators selling mortgages to the GSEs. It is a bad thing to have investment banks buying CDOs from the GSEs to market them to investors as a high yield Treasury bond. There was not a single quote of hers that undermined my argument. I then pointed out to you, that after going to great lengths to find a few passages that don’t name the GSEs directly, you somehow managed to miss the first couple chapters of her book that spell out her very lucid causal thesis about how GSEs corrupted our entire financial industry. To demonstrate to you how to represent an author in full context, I provided large block quotes from her that spelled out in full her precise causal claim. So your next step is to quote from a book review? 

          You have the book, why cling to a book review? Perhaps a better question is why misrepresent the book review the same way you tried to misrepresent her book? You fished for tight little clips that mentioned bankers doing bad things knowing full well that I agree bankers did bad things, but you ignore the body of the review’s text that told readers why Morgensen argues bankers were able to do these things:

          “The mortgage crisis started with the “housers” —President Clinton and others who pushed for creative mortgage financing because they believed more Americans should own their own homes.Then quasi-public Fannie Mae and Freddie Mac did away with their traditional underwriting criteria. That resulted in a wave of new mortgages and produced profits that pumped up executive bonuses at both institutions.Then private mortgage execs took cues from Fannie and Freddie and wrote loans for individuals who would not have been deemed creditworthy a few years earlier.”

          Again, bankers, politicians, and regulators are all greedy. They worked together to subsidize the price of risk of a financial product to enrich themselves against the public interest. There is no regulation that can prevent a crisis when the regulators themselves are involved in causing the crisis. The greatest insight in Morgensen’s book is the way Fannie Mae as a GSE could lobby in a way that Goldman Sachs never could. 

          In your desperate search for a premise to support your capital letters argument, you fell upon Brooksley Born. If only the Clinton administration had listened to her we could have avoided “this mess” you said. I showed you how her proposal added more problems than what it tried to solve for. I gave you 6 reasons why her proposal was rejected for good reason, that her proposal would have made our crisis worse, and you refused to respond. When you finally made something of an attempt to support your one premise, you merely provided a link to an interview with Born herself that not only addressed only one of the problems of her proposal but even made multiple verifiable factual errors. Your response was to parry her errors away because you don’t have time to be bothered with such inconvenient facts. Now you claim she has not been central to your argument? Even more bizarre is your use of a negation to say this: “My assertion was that we know that NOT adopting her recommendation ended in the crisis” So here you are playing with synonyms of cause again. It did not cause the crisis it “ended in the crisis.” It’s not the failure to adopt her proposal that ended in the crisis. It’s “NOT adopting her recommendation” that ended in the crisis. And then you wrap it all up with this beauty: after actually using the word “know” in front of this causal claim you follow it with your radical skepticism safety blanket. Here it is in full: “My assertion was that we know that NOT adopting her recommendation ended in the crisis. We don’t know the counter factual.” Logic is not your thing is it?

          This makes a great segway into a counterfactual you are more openly comfortable with, Raghuram Rajan’s proposal, which Dodd Frank adopted having rejected Born’s hare brain scheme. I never cherry picked anything from Rajan, indeed I never mentioned him at all. You brought him up. Without committing the logical fallacy of an appeal to his authority, I offered his proposal long ago on its merits as a rational way of dealing with obvious problems in the CDS market without adding more problems like Born would have by replacing AIG with a giant GSE that would have taken down the entire CDS market with it. Rajan pointed out that since expansionary monetary policy systemically misprices risk, it must necessarily lead to the mispricing of the CDS market leading to the possibility that an institution will sell more liability than it can cover. Makes perfect sense to me. I have no ideological reason to reject his analysis. I find it quite convincing and am comfortable with his counterfactual claim that had AIG been mandated to purchase reinsurance it would not have defaulted on its CDS owners. 

          Since AIG’s default was an effect of the crisis not its cause, this does not support your capital letters argument. If AIG was able to pay its counterparties, we would still have our small banks and credit unions clinging on to TARP money for dear life, hundreds of them failing, underwater homeowners, and a nasty recession. Rajan does not even support this new lower bar you have set for yourself “unregulated new financial instruments increased systemic risk.” Rajan came up with a sensible way of dealing with the way loose monetary policy affects the CDS market. What your capital letters argument needs is an idea as convincing as Rajan’s that deals with the mispricing of the CDO market when the thrust of public policy was to turn risky mortgages into Treasuries using GSEs as an intermediary between originators and marketers. Facts being such stubborn things, you have responded to this challenge by making all manner of logical leaps to avoid the obvious.

          If you don’t think Keynes thought government spending will catalyze sustainable growth from the private sector, you have not read the General Theory. NeoKeynesians have not dropped that core claim either. NeoKeynesian might be the wrong word but I know what you mean. The thrust of contemporary economists that are trying to salvage something from from Keynes, is a microeconomic analysis of wages and a desperate hope that government spending yields a multiplier. The latter completely died in recent years. The spending multiplier was the free lunch I was referring to. Japan’s results speak for themselves, but the empirical studies of our own economy that lacks many of Japan’s self inflicted woes has so discredited Keynes, that it really is now just talking point for politicians and stakeholders of government spending. 

          So it appears you have conceded that home ownership does not build middle class net worth, with one word “no.” I don’t see any real hedging of that word “no” when you go on to remind us what a great job you did committing the logical fallacy of mistaking association for causality.

          • valley person

             “You however selectively picked quotes where she appeared to be saying something bad about private companies.”

            Appeared? No “appeared” Eric. She flat out said every bad thing about private financial companies that I have been saying.

            “There was not a single quote of hers that undermined my argument.”

            She said that the bubble and crisis had many parents, not simply GSEs and not simply Barney Frank (she makes a way weak argument on Frank that you simmply repeated by the way). She gives GSEs a larger role than I do, which is her perogative. But she also gives financial institutions and traders a much larger role than you do.

            “I then pointed out to you, that after going to great lengths to find a few passages that don’t name the GSEs directly”

            On the contrary, I didn’t go to any lengths beyond googling her name and opening up a lengthy excerpt from her book. I didn’t seek out that excerpt. It was right there, the first thing on her. 

            “So your next step is to quote from a book review? ”

            Sure, why not? I have not read her book. Presumably the reviewer did. If the reviewer found the same argument I presented, then why not refer you to it?

            “You have the book, why cling to a book review?”

            Because I don’t have the book. Nor have I read the entire book. Only excerpts. I never claimed otherwise did I? (Cling? I hadn’t realized I was clinging. How un courageous of me!)

            “The mortgage crisis started with the “housers”…..

            Yes, she wrote this. I disagree with her and you on this conclusion based on the facts in evidence, as do others of equal stature to her.

            1) F&F did not buy subprime loans, but rather “Alt A” loans that were nearly as good as prime.
            2) They bought these late in the game. 

            Lots of people have looked at this issue, including: the nonpartisan Government Accountability Office, the Harvard Joint
            Center for Housing Studies, the Financial Crisis Inquiry Commission
            majority, the Federal Housing Finance Agency, and many academics. They all concluded that while F&F made huge investment mistakes, they were for the most part a victim of the crisis, not a perpetrator. They did not buy “nontraditional” mortgages in quantity until 2005, well after the bubble had formed and only shortly before it ended. During the main part of the bubble formation, the share of mortgages purchased by the GSEs actually declined substantially from where it had been in the 90s.

            https://research.stlouisfed.org/conferences/gse/Van_Order.pdf

            “It did not cause the crisis it “ended in the crisis.””

            Yes. Excuse my syntax. Try it this way:

            1) Borne recognized a problem with derivitives
            2) She made a proposal to have her agency regulate them
            3) Proposal was ridiculed and rejected by free market geniuses like Greenspan
            4) Financial lobby got law passed prohibiting her agency from ever regulating derivitives. Don’t even think about it.
            5) Housing bubble formed, burst, and ENDED, in part fed by the false security of derivitives.

            Her advice was rejected. Her warning came to pass.

            “Logic is not your thing is it?”

            Its perfectly logical to admit to lack of perfect knowledge. Humility must not be your thing, is it?

            “Since AIG’s default was an effect of the crisis not its cause, this does not support your capital letters argument”

            The AIG default was an effect of the crisis, but it was also a cause in the spread of the contagion that caused capital markets to seize. And it was symptomatic of the increased systemic risk that evolved as a consequence of the creation and deployment of new, unregulated financial instruments and their role in juicing the bubble. Bond insurance that is tied to a market is not like fire insurance. If the entire market tanks, the insurance can’t be redeemed. AIG (a Triple A rated business by the way) took the easy money while it was available, but in effect they were running a high stakes gambling operation hidden in plain sight. Buffet also warned about all this by the way, well before it came apart.

            “the thrust of public policy was to turn risky mortgages into Treasuries
            using GSEs as an intermediary between originators and marketers. ”

            See above. Most of the most risky mortgages bypassed the GSEs. Like you say, facts are stubborn things.

            “a microeconomic analysis of wages and a desperate hope that government spending yields a multiplier.”

            The CBO says there is a multiplier. And nearly all private forecasting I’ve seen on GDP growth includes a multiplier for federal spending. Are they all desperate?

            “So it appears you have conceded that home ownership does not build middle class net worth, with one word “no.”

            Geez Eric. Is this really how you win debates? My “no” is acknowledging that I did not prove that  home ownership is a for sure a priori contributor to net worth. What I followed with should make my argument clear to you. The correlation between owning one’s home and having a middle class level of net worth is very strong, suggesting a link. I’m waiting for you to show me the data on all those high net worth renters who  out smarted the masses.  

            In closing, I have to thank you for pushing me to do more reading and research into the housing bubble and subsequent crisis. I feel like I know a lot more now, and that what amounted to intuition that this crisis was primarily a market failure has been reinforced.

            I think you need to look at this whole thing from a different angle. Step outside your natural distrust government, free market fundamental framework and look hard at the actual sequence of events. Look at what the GSEs were really doing, and what role they played in the private mortgage markets. Look at how the dominoes came down, how every basically unregulated investment bank in the nation went ass over tea kettle.

            You are a smart, well educated guy Eric, with a curious mind. I have faith you will eventually draw different conclusions about the role private finance played here.

          • Gretchen Morgensen does not give financial institutions a larger role than I do. The article I wrote above and the posts I have made below are all about identifying how greedy bankers, politicians, and regulators work together to enrich themselves against the public interest. I don’t necessarily use normative terms like “evil.” I don’t think the folks who worked at the Fannie Mae were any worse than the folks who worked for Goldman Sachs. The matter at hand is not good institutions vs. bad ones; it is good public policy vs. bad public policy.  

            I have to wonder if you actually read Van Order’s paper. Perhaps you should read it again and asses if it really supports your capital letters argument. Before I show you how that paper undermines your argument, let’s examine those two facts you tout. First that the GSEs bought AltA rather than subprime. He never claimed as you did that AltA is almost as good as prime. There is a huge difference between prime and AltA; there is very little difference between AltA and the the new technical meaning of subprime that developed after 2004. AltA is a policy making euphemism for subprime. It includes all loans that are not prime but whose borrower has never filed for bankruptcy. High income to payment ratios are AltA. Loans without documentation, sometimes called “liar loans” or NINJA loans (for no income, no job, and no assets) are AltA. People with no credit history or terrible credit who never filed for bankruptcy are all AltA. 

            The second fact you tout is that the GSEs bought late into the game. He never said anything like that. He pointed out that subprime lending existed before the GSEs entered the market. This is not in dispute. The policy question before us is how the market changed when the GSEs intered it. What I think you are gravitating toward is when he downplays the size of the GSEs’ subprime purchases. This comes primarily from his methodology. He makes very clear that his source is the GSEs’ financial statements from the period. Our buddy Rajan has pointed out why this method is misleading in his book Fault Lines:

            “The Bush administration pushed up the low-income lending mandate on Fannie and Freddie to 56 percent of their assets in 2004, even as the Fed started increasing interest rates and expressing worries about the housing boom. Charles Calomiris of Columbia University argues that Fannie and Freddie moved into even higher gear at this time not so much because of altruism, but because the accounting scandals that were exposed in those agencies in 2004 made them much more pliant to Congress’s demands for more low-income lending. How much lending flowed from these sources, and when? It is not easy to get a sense of the true magnitude of subprime lending by Fannie, Freddie, and the FHA, partly because as Edward Pinto, a former chief credit officer of Fannie Mae, has argued, many loans on each of these entities’ books were sub-prime in nature but not classified as such. For instance, Fannie Mae classified a loan as subprime only if the originator itself specialized in the subprime business. Many risky loans to low-credit-quality borrowers thus escaped classification as subprime or Alt-A loans. When the loans are appropriately classified, Pinto finds that subprime lending alone (including financing through the purchase of mortgage-backed securities) by the mortgage giants and the FHA started at about $85 billion in 1997 and went up to $446 billion in 2003, after which it stabilized at between $300 and $400 billion a year until 2007, the last year of his study. On average, these entities accounted for 54 percent of the market across the years, with a high of 70 percent in 2007. He estimates that in June 2008, the mortgage giants, the FHA, and various other government programs were exposed to about $2.7 trillion in subprime loans, approximately 59 percent of total loans. It is very difficult to reach any other conclusion than that this was a market driven largely by government, or government-influenced, money.” (p. 38)

            The greatest irony here, is that Van Order’s paper undermines you capital letters argument in two ways. First, his paper downplays the role of the GSEs by placing more cause on monetary policy. He argues that the excess liquidity the Fed had created offered more demand for these securities than the GSEs could meet. I don’t dispute that at all. Rajan points out that Van Order is just not asking the next question as to why investors were attracted to this particular market in the first place rather than another. Expansionary monetary policy guarantees us a bubble; the particular contours of an economy decide where it will be. 

            The second way Van Order’s paper undermines your capital letters argument is the way he defends securitization. He makes the liquidity/solvency distinction to show that the GSEs’ formerly AAA subprime tranches have not been defaulting; they have simply lost market value due to their credit downgrades. Back in 2006, I thought all this stuff would be worthless, defaulting all over the place. I was overly pessimistic. Most people think all these tranches have defaulted. This undermines your argument because we know real estate bubbles can be formed without securitization. Van Oder points out how the effects of our bubble have been mitigated by securitization, something Sweden, Japan, and our small banks and credit unions could have used. Like I said, read his paper again – in full this time.

            I detect no epistemic humility in your most recent claim that had the Clinton administration adopted Born’s proposal we would not have had this crisis. Perhaps you can now make an argument why replacing AIG with a huge GSE would not have made matters worse as everybody rightly recognized. How does a giant new GSE’s monopoly role as an intermediary in the CDS market, placing the illusion of liquidity on an OTC product not cause a worse crisis? If no one defaulted on their CDS obligations would we not still have a real estate bubble, small banks and credit unions in desperate need of TARP money, building tradesmen being laid off, and a nasty recession?

            The CBO assumes a multiplier greater than one in its analysis, helping to explain why it always overstates GDP growth in its forecasts. It contracts to Moody’s Analytics to get its numbers. We know how seriously to take Moody’s research. Moody’s does research for the sellers of products not the buyers. If you think most private forecasters use a multiplier greater than one for government spending, you somehow missed the tectonic change in forecasting that occurred when Valery Ramey published this: 
            https://www.nber.org/papers/w15464.pdf
            and Robert Barro published this:
            https://www.nber.org/papers/w15369.pdf

            On the myth of homeownership wealth building, I had stated: “You did not point out that home ownership contributed to higher net worth.” You replied: “No, but it is correlated with net worth to such a high level that one can’t help but think they are closely linked.” Anyone who commits the logical fallacy of mistaking association with causality has established a link. You have simply moved from the word “correlated” to the word “linked”, but you have not articulated an explanandum how a net cost builds wealth. 

          • valley person

            ” Gretchen Morgensen does not give financial institutions a larger role than I do.”

            You don’t seem to give them any role at all rather than having been helpless automatons who simply HAD to move money into housing through exotic financial instruments they themselves invented and controlled because the government MADE them via monetary policy and GSEs. She certainly assigns them a much greater role than that.

            “I have to wonder if you actually read Van Order’s paper.”

            I actually skimmed it. Financial minutia is not my cup of tea. On page 15, his summary, he states in terms that cannot be misunderstood that “Fannie and Freddie did not cause the subprime boom and bust.” He doesn’t even say they caused it a little. Basically he says they had nothing to do with it.

            And he goes on that the F&F debacle was due to loans originating AFTER 2005, which was late in the bubble by any definition. And that the core issue with F&F was the rapid decline in the value of equity, not in foreclosures.

            These findings clearly agree with my premise and contradict yours no?

            “There is a huge difference between prime and AltA; there is very little
            difference between AltA and the the new technical meaning of subprime
            that developed after 2004.”

            The record on Alt A loans is that their foreclosure rate has been barely higher than conventional loans, while foreclosures on true subprimes are multiple times both.  Your man Pinto attempted to make a case against F&F by conflating these 2 loan categories. He was pretty thoroughly debunked by a number of analysts on the basis of foreclosure data.

            Fannie and Freddie did not originate subprime loans, they did not buy much in the way of subprime loans, and therefore had little or no effect on the subprime market that clearly was the chief engine behind the bubble and its collapse.

            Back to monetary policy. I’ve agree that low interest rates “facilitated” the development of the housing bubble. Our disagreement is over a couple of things:

            1) Whether a housing bubble was inevitable because of monetary policy
            2) Whether the size of the bubble and its subsequent damage to the greater economy was caused by monetary policy and
            3) Whether we would be better off with a monetary policy on automatic pilot, which is what you claim the Swiss, Swedes, and others have done.

            On points 1 and 2; As I’ve stated earlier, the government and Fed had multiple opportunities to intervene in the bubble early on to prevent it from getting too big too fast. There was a free market will sort it out belief, from late stage Clinton through Bush, and especially Greenspan. I won’t re-hash what they could or should have done again. But even assuming monetary policy was a necessary pre-requisite to the bubble, it simply doesn’t follow that policy makers and regulators had no ability to minimize it. This was about choices not made due to a deregulatory, free market mindset.

            “I detect no epistemic humility in your most recent claim that had the
            Clinton administration adopted Born’s proposal we would not have had
            this crisis. ”

            That is because you keep misunderstanding my position. I have never claimed that had Born’s proposal been adopted the crisis would have been averted. I pointed out the historic fact that her proposal was not adopted, and we did have the crisis. Adopting her proposal may have helped and it may not have helped. We will never know. You say what she proposed was in effect another GSE. I didn’t read her proposal that way. I read it as regulatory, not as a guarentee of payment on claims. Many insurance products are regulated without any government guarentee.

            On 3, I don’t know the answer, but it seems to me that by statute the Fed has to manage the money supply to balance inflation and unemployment. Your proposed automatic pilot might accomplish this, but what would your measure of success be? How long would we have to run the  experiment?

            (Hong Kong, Singapore, and the rest use minor world currencies. The US dollar is clearly not like other currencies, and provides us with a rather unique opportunity to rent our money out at very low interest rates pretty much whenever we choose. This has good and bad consequences. Good in that it is really easy for us to raise capital to fund government. And bad for the same reason. It allows us to pile up debt with no apparent adverse consequences, so since the time of Reagan, but for  brief interlude with Clinton, we have divorced our taxation from our spending. It allows us to live beyond our means, and allows the Republican Party to take no tax pledges while railing against Medicare and defense cuts. And it allows Democrats to dig in over otherwise unsustainable middle class entitlement programs. )

            “If you think most private forecasters use a multiplier greater than one
            for government spending, you somehow missed the tectonic change
            in forecasting …”

            All GDP growth forecasts are higher with higher government spending and lower without it irrespective of what multiplier is used. That suggests there is wide agreement that government spending is a “stimulus” to higher GDP.

            “Anyone who commits the logical fallacy of mistaking association with causality has established a link.”

            Yes, and since I flat out stated that there is probably a link, you have just accused me of what my position is. What I don’t know is whether buying a home is an act that establishes conditions that lead to wealth building beyond what would have occurred without buying a home. Your analysis is binary. You take an initial investment as down payment, assign it to another investment, assume that “renting” money to make payments plus associated ownership costs is greater than renting a place to live (no data, just assumptions), and then assume a given home owner would have been better off financially had they never taken out a mortgage.

            You conveniently ignore at the actual situation of net worth in America, which is an overwhelming (40 times) correlation between home ownership and net worth, suggesting to anyone not blinded by ideology that there is more going on here than your binary model suggests. Perhaps the relative stability that comes with the mortgage triggers a set of behaviors that results in wealth building. Perhaps it is something else. But is it simply an accident that there is such a huge net worth gap between owners and renters, far beyond what income or other differences suggests?

            Here is an explanandum(?) for you. People who buy homes, as a general rule, build net worth better than those who rent due to a combination of factors:

            1) Home values rise an average of 7% per year over time
            2) The greater stability of home ownership (versus renting) results in building economic and social/community relationships  that help one get ahead professionally and financially (value of networks)
            3) Home owners can cash in on temporary price spikes to tap equity for other investment purposes or to “trade up” to greater equity
            4) Homes (other than the last few years have been one of the most stable investments available to the middle class (lack of volatility) 
            5) There are tax advantages to home ownership
            6) Middle class people in general are not savvy long term investors. Those who try other investment approaches run market risks. (I have some friends who fit this to a tee. Have rented for years, invested a lot in equities and lost a lot). 

          • I’m afraid I am going to have to let that be the last word. I have a busy week ahead that will not afford me the kind of free time I had last week. I have enjoyed our conversation very much. 

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