There's a certain amount of moral outrage floating around in the punditocracy, looking for a solid target. The implication is that someone, or at least some small group of people, must have done this to us in the course of feeding their insatiable greed. I'm sure there will be a post-mortem in which some reporter will tell a very convincing story about how this could all have been averted if only someone had Made A Rule. It may be Bear's managers who should have done it, or the Fed, or the SEC. I don't know who the culprit will be, but I am very sure that everyone else will be very sure that Someone could have (and should have) prevented all this.
Before we enter into the orgy of blame, I'd suggest that that someone was everyone, almost. Crazy Asian people who thought America was some sort of Miracle Market sent us more money than we needed for investment, inflating an asset price bubble. The Federal Reserve, complacent after more than twenty years of tame inflation, added a little kerosene to an already blazing fire. Silly people decided that real estate prices would continue rocketing upwards forever, and took on ridiculous mortgages that they had no reasonable hope of paying off. Idiot bankers thought that their enormous brains, raffish good looks, and advanced computer models had enabled them to conquer risk.
A couple of years ago, I had dinner with an investment banker who had gone to Chicago a few years before I did. He spent a great deal of the time extolling the virtues of modern markets, proclaiming that over the last ten years, we'd become massively better at pricing risk.
Being a great fan of John Kenneth Galbraith's work on asset-price bubbles, I felt the hair go up on the back of my neck. "Are we really better at it?" I asked. "Or do we just think we are?"
"No, we're really better," he assured me. Ooops.
I mean, I think that in fact we did get a lot better at assessing credit risks--but not nearly as much better as we thought, a fact that for a long while was masked by the river of money flowing into the US from abroad. Bankers, seeing their credit models worked so well--in fact, defaults were lower than expected!--took on even more risk.
But while the bankers are in some sense the most directly culpable, they didn't behave in any fundamentally different way from millions of their fellow citizens. There were incredibly unwise decisions all the way down the chain from lenders to homebuyers, and each of those bad decisions was necessary to create the current mess. We're witnessing the ugly denoument of a sort of folie-a-millions.
Give it a few years, there'll be yet another asset price bubble. Maybe it'll be tech stocks again.
What we're seeing is nothing more than the PASS rule in action: People Are Such Schmucks.
Don't you think it's important to distinguish between the mistakes made by home buyers and lenders. Home buyers do not study the housing markets professionally, and they do not have a strong understanding of macroeconomics. They have less ability to judge whether an adjustable rate mortgage is likely to put them into foreclosure or not. Lending institutions study these things professionally and should know better. In fact it seems rational for home buyers to assume that lending institutions have done their homework, and that if they have agreed to extend a mortgage to you, there is not too much risk of foreclosure. The problem is that due to agency problems of the lending institutions own creation, they had not done their homework. The actions of many home buyers were irrational and stupid but the ultimate source of the problem was in the failure of professionals in lending institutions to do their job well.
That being said, if the home buyers had shown better juddment things wouldn't be so bad. Perhaps this episode will be a strong argument for actual required economics education in high schools.
Wait, let me get this straight:
First a bubble was inflated, set on fire, doused in kerosene, and then rocketed into the heavenly firmament?!?
I definitely could have seen that coming.
This is a bumper, sending the pendulum back from the greed direction to the fear direction.
We like fear because we get bored with greed. It's fun! At the peak of the bubble, movies created cheezy rubber-spider slasher movies that synthsized fun so the kids could see what was in store.
Apparently, each generation has to learn this the hard way. *Shrug*.
// the road goes on forever and the party never
// ends
Wall Street bonuses have been running at about $20 billion/year for the last few years. While collecting these bonuses, the big swinging dicks have propelled us towards the current crisis at a time when median incomes have been flat. When people proposed taxing hedge fund managers like normal people, people decried it as "class warfare". JP Morgan has stated that they're setting aside $1 billion for severance to Bear senior executives, including CEO Schwartz. A certain degree of moral outrage seems justified.
Much as you dislike the very idea of regulation for the Financial Institutions arena, it might be helpful to consider how the companies that were among the worst actors in this area managed to aviod regulation until it was too late
Countrywide was essentially an unregulated venture. Since it relied on outside capital rather than deposits to fund its loans, it was not an FDIC insured and therefore never had to temper its lending policies to the restraints imposed by a regulator. Perhaps it would not have been a bad thing for a regulator to step in, as a relatively lax FDIC finally did with a Countrywide competitor, Fremont, and restrain them from allowing loan officers to accept “Stated Income” applications and from employing preferred assessors to overvalue real estate.
Fremont was issued a cease and desist order in February of ’07; Countrywide, and many other similarly unregulated ventures, continued to generate sub-prime loans through August when the market finally collapsed. A regulator that had oversight of the business practices of these companies might have been able to slow down or even deter the use of irresponsible practices.
Considering the downside, this would not have been such a bad thing.
Tell us again how CEOs earn those huge salaries because they're so much smarter than the rest of us. And tell us that you're sure no fraud was involved in billions of dollars in bad loans being made, and that regulation couldn't have improved matters.
Denial -- it's not just a river in Egypt.
You assert that "everyone" was to blame for this crisis. If this is true, the subprime crisis is a perfect counterexample to a first assumption of economics: rational behavior. According to you analysis, it seems that everyone did not act rationally, but rather that everyone acted irrationally. If you believe that irrational behavior is sometimes the norm, then why do you think the market acts rationally and optimally when not interfered with by government? And how do Fed bailouts factor into this fantasyland of unfettered markets?
You assert that "everyone" was to blame for this crisis. If this is true, the subprime crisis is a perfect counterexample to a first assumption of economics: rational behavior. According to your analysis, it seems that everyone did not act rationally, but rather that everyone acted irrationally. If you believe that irrational behavior is sometimes the norm, then why do you think the market acts rationally and optimally when not interfered with by government? And how do Fed bailouts factor into this fantasyland of unfettered markets?
But while the bankers are in some sense the most directly culpable, they didn't behave in any fundamentally different way from millions of their fellow citizens. There were incredibly unwise decisions all the way down the chain from lenders to homebuyers, and each of those bad decisions was necessary to create the current mess. We're witnessing the ugly denoument of a sort of folie-a-millions.
If everyone was greedy, then greed isn't a really useful metric for deciding culpability in this situation.
Who has more responsibility for the overall health of the banking system, the greedy potential borrowers or the greedy bankers? I say it's the greedy bankers -- the system gives them vast rewards, so they should care the most about it, and if the system fails, they are the ones who weren't doing their jobs. The borrowers are always going to want more than it's smart to give them.
While you’re decrying the irrationality of market actors, (I guess implying that eminently rational regulators can counteract this intractable feature of capitalism), why don’t you define what rational behavior is, in fact? Does it mean making a decision that only leads to positive, efficient outcomes? Or is it simply a fancy way of saying “seemed like a good idea at the time”?
When you take several aspects of our pre-crash economic state of affairs into consideration, and analyze many of the perverse incentives gestated in a mercantilist fiscal and monetary policy, you realize that people acted in very predictable ways, making this crash quite predictable as well. Are we to believe that people completely forgot about the origin and consequences of the tech bubble? That nobody realized demand for real estate would eventually reach a critical mass? Both consumers and financial institutions are responsible for knowing what they can and can’t afford. Leaving aside speculators, you could say that the average borrower was hoodwinked with guarantees of rising equity, but who hoodwinked the lenders, and the holders of CDO’s? Are we to accept that their econometricians didn’t understand the simple dynamics of a bank run??
Too many entities in this picture were able to externalize the costs of failure, and therefore didn’t make “rational” decisions that took the risk/cost of failure into account. That’s what moral hazard does. Why act responsibly when you’re not held responsible for anything? Socialism for the poor or socialism for the rich—both equally destroy personal responsibility and the ability to economically calculate. Both are fertile matrices for waste, fraud and injustice.
Interesting, but dammit if I did not write this post 8 goddamn months ago!.
Maybe I should become an economics blogger!