Some Sanity On The Financial Crisis
Posted on October 8th, 2008
by Daniel Larison |
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As many authoritative economists are desperately trying to explain amid all the confusion, the culprit was a system geared toward loaning money to people who were not in a position to pay it back. Two policies underpinned that system: easy money by the Federal Reserve and the government-induced lowering of standards for approving loan requests.
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The fact that, as Sebastian Mallaby pointed out in a recent op-ed in The Washington Post, “lightly regulated hedge funds resisted buying toxic waste for the most part” also belies the notion that deregulation was the culprit. The real purchasers were U.S. investment banks regulated by the Securities and Exchange Commission, U.S. commercial banks regulated by the Fed, and European banks that are among the most regulated in the world. ~Alvaro Vargas Llosa
It is therefore all the more depressing that Obama has chosen to denounce generic deregulation as the main culprit, while McCain has opted, as usual, for uninformed moralizing against private sector corruption. Of course, if I were the nominee of the party that championed the mortgage lenders or the nominee who loved Greenspan so much that he wanted to keep him as Chairman even after he died (notice that McCain doesn’t tell that joke anymore), I would probably try to find something else to talk about.
The trouble arose because of the effective collusion between government agencies and investment banks on the one hand (allowing the latter to become horribly overleveraged), and because of large-scale government involvement in the housing market through the government-backed mortgage lenders and loose monetary policy on the other. The latter made possible the creation of the housing bubble, while the extraordinary risk-taking that the government backing of the lenders permitted helped make the bubble larger than it would have otherwise been and ensured that it would collapse more violently. The past two administrations and both parties share in the responsibility for this, and the bipartisan cult of Greenspan has much to answer for as well, but it is also perfectly fair to place the bulk of responsibility on the people who were in the majority and in control of the White House as the problems were growing and being exacerbated by many of the policies that they supported. Now to solve the problems created by past intervention and collusion, they offer more intervention and collusion.
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18 Responses to “Some Sanity On The Financial Crisis”
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I don’t think that Llosa’s argument proves very much– the issue is not whether the institutions were subject to any regulation at all, but rather whether the regulation was adequate.
Fannie Mae and Freddie Mac are really not at the core of the problem that we’re now facing. As explained here:
More information is available at this podcast. The root of the bad loans is not a Carter-era law forbidding discrimination (that isn’t your claim here, Daniel, but I’ve seen it made elsewhere), but rather new financial instruments that met the desire of large institutions for safe investments.
Now, it’s of course reasonable to say that you don’t believe that the government should be trusted to regulate these sorts of things, and that’s fine. But I don’t think it’s fair to say that the bad loans in this instance were caused by government intervention and overregulation.
Many bad loans were made possible by incredibly low interest rates and the active encouragement of the public to take out adjustable rate mortagages by the Fed Chairman himself. The Fed and its Chairman had a lot to do with facilitating the mess, and if the Fed’s manipulation of the money supply doesn’t count as government intervention I’m not sure what would. Llosa does address the subsequent creation of financial instruments, which compounded the problem.
Can anyone explain to me how Mallaby and other hedge fund cheerleaders can be so cocksure that the hedgehogs are sitting pretty. I saw an article in the Chicago Tribune about the Citadel firm and its Harvard MBA wunderkind founder’s Icarus impersonation of late. Not to mention the LTC inicident, which was the mother of all deregulation disasters and some argue the precedent for the current People’s Republic of Wall Street.
Don’t get me wrong, I’m with you on the need for Fannie and Freddie’s to have been taken out like Steinbeck’s Lennie years ago. (Putting my cards on the table, Wright Patman had the right idea on the Federal Reserve) That’s where Bobo Brooks and Mallaby do exactly what you rightly accuse McCain of: lying. They want regulation on the terms such as the Fed’s unconsitutional control over our economy, and LTC, Goldman Sachs’ Mexican Peso, and the current 5 year plan, that helps those whose bidding they do. Screw everybody else, else which if you read Barton Biggs “Hedgehog”, is the raison d’etre of those benevolent unregulated bucaneers of high finance.
America) But what galls me is Mallaby and other cheerleaders for the current 5Can anyone explain to me how Mallaby, Llosa and Bobo Brooks can be so cocksure the hedgehogs are sitting pretty right now? (Maybe their moonlighting with econometric regression models and scribbling pro bono publico, but I doubt it somehow) Chicago Tribune just ran a piece on the Harvard MBA wunderkind who founded a leading hedge fund, Citadel Capital Management, and he and his firm’s Icarus impersonation of late. Not to mention the LTC disaster, which was the mother of all deregulation calamities that necessitated our tax dollars outflowing to save the 2big2fail and (and of course the Dow) in what some argue was the blueprint for the new People’s Republi of Wall Street. I thought one of the virtues of hedge funds is their imperviousness to meddlesome SEC examiners and other statist losers: i.e., they let us know how they’re doing, as LTC did, when they’re good and ready.
Don’t get me wrong, I’m with you on Fannie and Freddie needing to have been taken out back behind the barn like Steinbeck’s Lennie years ago. (Putting all my cards on the table, Wright Patman was way ahead of you on the same being done to the unconsitutional monstrosity of 1913 that Wilson and Col. House foisted on post-Morgan year plan’s)
What galls me is the likes of Mallaby and Brooks current pivot to “regulation is the problem”, which is as mendacious as what you rightly accuse MyFriends McCain of doing. They have no problem with regulation as long as it is used to benefit those whose bidding they do. Screw everbody else. Which, according to Barton Bigg’s “Hedgehog”, is the raison d’etre of all those rugged John Galts out there bucaneering from Bermuda to San Moritz. There are no heros in this tragedy. Not even the hedgehogs and especially not there little mouthpieces in DC.
sorry, I love your writing normally, but this hedge fund stuff is real nonsense. Bear Stearns was dragged down by the failure of two hedge funds!
Dozens of hedge funds have gone under in the last year. I expect more will soon. Because the funds are so totally unregulated, we know effectively nothing about what hedge funds bought or how much vulnerability they have. (In other words, Mallaby is lying when he implies any knowledge of whether funds bought bad assets).
Finally, hedge funds were counterparties on lots of these bad assets. If, for the sake of argument, it eventually turns out that they sold lots of crap to others, helping drag down the whole system, but were smart enough to avoid buying it themselves, is that good?
What you’re right about is that government policy was very complicit in this. But it’s more about the Fed flooding the economy with easy money then about Fannie and Freddie, who were not at the center of this. (They joined the subprime party quite late (2005-06), using as an excuse that the private sector was already fully behind this stuff).
As backup to my claim that dozens of hedge funds have gone under, check out the hedge fund implode-o-meter . 84 hedge funds going bankrupt since mid-2007.
The Fed and its Chairman had a lot to do with facilitating the mess
Absolutely true. We wouldn’t be in this position if Paul Krugman had been chairman.
Daniel please, this happened because no one was watching. It’s not about low interest loans being forced on banks by the gov’t. It’s about greed. Banks made those laons because they were able to make money doing so not because the fed forced them. They came up with new interest schemes so they can get more people into higher loans that have higher returns so they can sell them faster on wall street. If someone was watching or if Congress had decided back in the 90s that CDS should be publicly traded this wouldn’t have happened. Follow Elvis’ link to the NPR podcast 355, then listen to podcast 365 which is a follow up. Listen to the reasons given by Congress for why the CDS market should be allowed to stay private. Then post an update.
I would agree, rawshark. Barry Ritholtz has an interesting take on this:
http://bigpicture.typepad.com/comments/2008/10/misunderstandin.html
“The CRA is not remotely one of the proximate causes of the current credit crunch, Housing collapse,and mortgage debacle. As I detailed in Barron’s, there is plenty of things to be angry at D.C. about — but this ain’t one of them.
If you were to ask me to reveal the prime causative factor for the Housing boom, I would point you to Fed Chairman Greenspan taking rates to 1%, and then leaving them there for a year. The prime factor in the bust was nonfeasance on the Fed’s part in supervising bank lending, allowing banks to give money to people who couldn’t possibly pay it back.”
We should take care to put blame where it belongs. The kinds of loans under the CRA program only constitute at most 25% of the loans involved in this crisis. It is primarily greed, laziness and people looking the other way on these things, and the eventual inability to regulate these CDOs and CDSs at all (thanks, Senator Gramm).
I am going to drag this down to Econ 101 levels.
A free market corrects itself.
Bernanke and Greenspan spent the last 10 years lowering rates every time the stock market tried to correct even slightly.
Therefore, America is not a free market.
All that other stuff – hedge funds, mortgage crisis,greed, excess, fraud…only symptoms of the core issue.
At the core? Price controls create shortages.
Exactly–If more people understood that the Fed basically fixes the price of money, it shouldn’t be too hard to connect that with the well known econ 101 general wisdom that price controls produce gluts and shortages by prohibiting market forces of real supply and demand from calibrating prices that reflect reality. So, DUH, you will get artificial booms and busts in capital accumulation. Not rocket science, folks.
No one should be suprised that a Wizard of Oz-based money economy is intrinsically unstable and perpetually weeks away from implosion.
Also, I think it’s a misnomer to call this a “mortgage crisis”, just as the 2000 downturn was not the result of an “internet crisis”…
This is a money and banking crisis, as has been true of most economic bubble trouble in history.
Don’t blame the athlete when the steroids are shoved down his throat.
The rate setting has nothing to do with the kind of bad underwriting practices that went on. The 1% federal funds rate stoked greed, but that didn’t mean that banks had to start issuing loans with no money down, no documentation. Forget the interest only ARMs and other hooziewhatsits. If they cared about getting their money back, they would have at least taken documentation of income. You cannot blame “the market” for this practice.
Indya, Those bad lending practices can only be explained by coercion, moral hazard and other perverse incentives, or an inexplicable, insane disregard on the part of managers and executives, overcome with “animal spirits”, for the financial health of their companies. I have trouble swallowing the last one. The first two seem more likely.
We also shouldn’t forget about foreign countries lending us incredible amounts of money to finance our consumption-on-credit way of life. Without the post-WWII dollar standard for global security detail quid pro quo, our entire modern lifestyle would never have been possible.
And when the global financial system abandons the dollar standard, things will never be the same.
I would say it’s moral hazard more than anything else. It is insane. Tom Toles has a perfect cartoon for this.
http://www.washingtonpost.com/wp-srv/opinions/cartoonsandvideos/toles_main.html?name=Toles&date=10082008&type=c
You are correct to bring up the foreign markets – in truth, that is the reason why anyone would even think about putting 700B or 1T toward the bailout. The debt would bankrupt us indeed if all the foreign investment left the US. But we’re not alone in this credit crisis – the entire system is structured to make money on other people’s money. It’s not just us dependent on loans to subsidize a higher standard of living. It is the modern business model – leverage. It’s insane that the financial industry was so heavily leveraged. Who saves up and buys things on cash anymore?
The dollar hegemony is on its deathbed, indeed.
“The rate setting has nothing to do with the kind of bad underwriting practices that went on….. ”
Absolutely it did! SImply put, lower rates means that banks have to loan more money in order to achieve the same returns.
This mortgage market collapse isn’t the cause of our economic problems…it is only a symptom.
Did you not read the next sentence?
The 1% federal funds rate stoked greed, but that didn’t mean that banks had to start issuing loans with no money down, no documentation.
Nowhere did anyone put a gun to their heads and say, “take no-doc loans!!”
The 1% federal funds rate stoked greed, but that didn’t mean that banks had to start issuing loans with no money down, no documentation.
Actually, they did on several levels.