Just in case you thought I was kidding about grooving on long wonky posts about important topics in financial regulation, I now pick on Ezra Klein. This is just not right:
It's got to be a scary moment if you're a conservative. The economy is in a meltdown that can be directly traced to insufficient regulation. In other words, it's in meltdown because you suck at running it, and refused to listen to warnings that subprime loans required more oversight, Glass-Steagall made sense, and somebody should really be keeping an eye on these increasingly odd financial instruments and the obvious housing bubble that was feeding them. There's only one thing to do: Blame liberals.
I in fact sort of agree with the point that Ezra goes on to make, which is that it's a severe stretch to lay the housing bubble at the feet of the Community Reinvestment Act. It is reasonable to blame the notion that homeownership is a priceless boon which should be extended to as many people as possible. That idea infected regulators, politicians, and potential homeowners at ever greater rates over the last ten or fifteen years, and it led to subtle changes at all levels which encouraged overlending/overborrowing. But the CRA was largely a sideshow to this.
However, this paragraph is just wrong in both implication and particulars. In some sense, this obviously could have been prevented by regulation; we could have outlawed all mortgages below Alt-A, for example, and jacked up capital requirements to fifty percent. This is a trivial observation, like noting that if we'd only kept all the hijackers off those planes, 9/11 never would have happened; you need to actually posit a regulatory framework that could a) prevent disaster b) do so without gigantic other costs and c) actually get passed before everyone knew that the disaster was going to happen.
The deeper implied argument, that there were regulations that we could have and should have implemented sooner, is somewhat true. Higher capital requirements, for example, are pretty much universally agreed to be long overdue. But financial regulation is usually better at preventing the last crisis than the next one. Consider some of the financial crises that rocked us in recent decades: currency speculation, banks recycling petrodollars to developing nations that defaulted, interbank lending, program trading, credit risk misvaluation. They all have one thing in common--leverage--which is why higher capital requirements do make sense, and it might be time to start looking at hedge funds. But while that would hedge the government's downside risk (only right, if it is going to be providing bailouts), it's not clear that this would have actually prevented the meltdown. Basel II is pretty much the state of the art in financial regulation, but as Seeking Alpha has noted:
With all due respect to the Nout Wellink and the other members of the BCBS, we do not believe that the implementation of the Basel II proposal or anything that looks remotely like it would have alleviated the ongoing collapse of the market for complex structured assets. When an entire asset class literally dies in a matter of weeks, the risk is infinite. To us, measuring the liquidity or market risk of a Structured Investment Vehicle ("SIV"), with or without the Basel II framework, makes about as much sense as using statistics to predict corporate credit defaults.Remember too that most of Basel II is based upon the very quantitative models and rating agency methods which caused the subprime crisis, thus offers of assistance from Basel II's creators within the BCBS should be viewed with caution. Basel II merely mimics the business processes of the Sell Side investment houses, systems which are intended first to enable new financial transactions and, as a secondary matter, manage the risk.
The fairly uncontroversial argument that some regulations might have mitigated our current problems has been transformed, in the minds of many commentators, into a belief that the meltdown must therefore have been the result of deregulation, or of rapacious financiers deliberately crippling the regulatory apparatus. Hence the frequent invocation of that magic name, Glass-Steagall, which of course can summon the spirit of FDR to fix the economy if only the president is brave enough to speak it three times aloud.
Contrary to popular belief, Glass-Steagall isn't magic, and also, hasn't been repealed. (Actually, there were two Glass-Steagalls, but for convenience, we shall treat them as a unified system). The sensible thing that Glass-Steagall did are pretty much all still in place--most notably the creation of the FDIC, which is thankfully still doing a pretty fabulous job of insuring bank accounts and winding up the affairs of insolvent banks. Glass-Steagall did other less sensible things which have slowly been eliminated. Regulation Q, which allowed the government to set interest rates on accounts, was gotten rid of in 1980, which is why you get a good interest rate from your bank instead of a free toaster when you sign up. It has not been much missed.
In the 1980s, commercial banks were allowed to affiliate with companies that floated securities, provided that this wasn't their primary business, and to offer a wider range of brokerage services. Citibank's in-house mutual funds are a rip-off, but they did not create the recent problems in the financial markets.
In 1999, we got rid of the rules barring commercial banks from owning investment banking arms (or vice versa, though this really hasn't happened much). This was supposed to keep speculation from taking out peoples' bank accounts, but two years after its passage, Glass, who had pushed for the provision, called it an overreaction and tried to get it repealed. At any rate, the commercial banks, which is what this regulation was designed to protect, have not been the problem during this meltdown. The act did nothing about hedge funds, and the most affected banks--Bear, Lehman and Merrill (which were threatened by the contagion) are pretty much pure play investment houses; Bear needed the balance sheet of a big commercial operation, JP Morgan, to bail it out.
That leaves that other talismanic incantation: "Regulate subprime markets". But what does this mean? Should we have capped interest rates? Set minimum credit rating or down-payment standards? Made securitization illegal? Securitization is still on net almost certainly a good thing, and I must point out, was itself invented by the government to boost homeownership. More to the point, how would you have generated the political will to do any of these things in, say, 2004?
Regulators are best at providing transparency and punishing fraud. But the opacity and fraud in the subprime market seem to have come out of the mortgage broker system, which is regulated at the state level. And the problem wasn't a lack of regulation, per se; it was bad regulation. In some states, the mortgage brokers had captured the process; these are the states that have the biggest problems. But it's hard to trace California's housing disasters to the fact that its legislature has been swept by deregulatory fervor.
I suppose one could make an argument that the subprime market was created by the end of usury laws. But there's a pretty decent literature showing that the alternatives the poor fall back on when interest rates are capped are even worse: pawnshops, loan sharks, or whatever desperate disaster they're borrowing money to avoid. And the usury laws were effectively repealed in 1980, which doesn't track any better with the timeline of the housing crisis than does the 1977 CRA.
The nature of the crisis is such that it fits some convenient narratives: the libertarian belief in overwhelming moral hazard, the Austrian fixation on the money supply, the liberal belief that a lack of regulation necessarily invites disaster. Now, each of these narratives has something worthwhile to offer to the discussion, but all of them are entirely too neat to provide anything like a comprehensive explanation, much less a solution.
Wasn't it reported that Greenspan was getting warnings from within the Fed that low documentation / Alt-A / subprime / exotic mortgages were getting out of control and they should tighten up the rules on them? But Greenspan chose to ignore his staff on that one. So this may not be entirely Monday morning quarterbacking. Presumably if Greenspan had heeded those warnings and done something about it -- rather than blithely recommending ARM's to Americans -- the worst excesses of the bubble wouldn't have come to pass and the let down would have been more general.
Let's assume for a minute that we do what some politicans are screaming for, and eliminate sub-prime mortgages, on the grounds that they constitute "predatory lending". What is the next thing we will hear? "Banks are 'red lining' minority neighborhoods!!!"
It won't be true, of course. But anybody want to bet two bits it wouldn't happen that way?
Leftist thought in a nutshell: Ezra Klein thinks the government "runs" the economy. Or, I guess, at least it *ought* to.
Megan, you get stick about being muddled and waffling because of writing like this:
How can Ezra be "just not right" and yet you "sort of agree" with him? How can a paragraph be "just wrong in implication" and yet be "somewhat true" in its "deeper implied argument?" And if each of the narratives have something worthwhile to offer but none of them are comprehensive much less a solution, can you envision a solution that makes use of these worthwhile somethings and is a comprehensive solution? Or is there no solution and we're just doomed to have these bubbles over and over again?
I never doubted that you had the capacity to be wonky if you wanted to. The challenge is not to out-wonk Ezra Klein but to make a counterargument that educates as well as engages. And verbosity is not necessarily a virtue.
"The 'ownership society' meme promoted by regulators and politicians encouraged overlending/overborrowing." Shorter Megan.
If the disaster could have been prevented by regulation, doesn't it make sense to, you know, have those regulations? Just because 9/11 only happened that one day doesn't mean that it can't happen again. Should absolutely no changes in air travel security be made, because the 9/11 horse is already out of the barn?
No, if it's only somewhat true it's quite false. Either it's true or it isn't. I happen to think it is true.
Assertion without proof. Your link only points to a lecture, which is going to be dry and boring (and I bet says nothing about regulation being unnecessary).
Imagine that. An "uncontroversial argument" actually leading to a conclusion!
And yet,
So parts of it have been repealed, right? Could it be possible that repealing those "less sensible things" might just be considered "deregulation?"
What do you consider a "good interest rate?" I get .5% (yes that's right, one half of one percent) at my credit union. That's good?
My retired parents, who rely heavily on savings interest for income, miss it quite a bit.
Those all sound good to me.
Assertion without proof...
Which we've already agreed was part of a misguided "ownership society" kick, right?
Vote for John Kerry:
http://www.usatoday.com/news/politicselections/nation/president/2004-08-26-kerry_x.htm
Two financial products would be virtually banned — loans that let the customer pay only interest up front, on the grounds that they pay off the entire principle at the end of the term, and insurance that requires homeowners to pay upfront instead of monthly installments.
Kerry drew on research by Harvard law professor Elizabeth Warren, whose recent book, "The Two Income Trap," lays out proposals for limiting financial industry practices that squeeze the middle class.
But of course, in 2004 it was more important to prevent gays from getting married. And Kerry windsurfed!
I suppose.
So it's better for the poor to get a mortgage they couldn't afford, get to live in a house they would be kicked out of in a short time, get their credit rating ruined for life, and bring the world financial system to the literal brink of total collapse, because otherwise they would have turned to pawn shops or loan sharks?
Is that seriously your argument here?
Actually, the analogy to the TSA is a good one, since they are always reacting to the last problem. Box cutters. Shoes. Liquids. The point is that NOBODY foresaw the subprime meltdown, so precisely *how* would someone have enacted regulations to prevent it? Sure, had we a time machine, we could fix it with regulations applied about ten years ago. But blindly enacting regulations to fix the last problem brought us brainwaves like Sarbanes-Oxley, which is acknowledged to be a ridiculous mess even by its erstwhile proponents.
"If the disaster could have been prevented by regulation, doesn't it make sense to, you know, have those regulations?"
You have to come up with regulations that aren't worse than the disease. Would you like to forbid sales of homes for more than 5% above their purchase price? Would you like to forbid poor people from buying homes?
MM: "Should we have capped interest rates? Set minimum credit rating or down-payment standards? Made securitization illegal?"
liberalrob: "Those all sound good to me."
What happens if inflation increases? Your capped interest rates end up ending mortages entirely.
What happens if the official government creditworthiness deciding organization chooses too high a credit rating? Plenty of worthy people end up renting instead of buying.
MM: "...you get a good interest rate from your bank instead of a free toaster when you sign up."
liberalrob: "What do you consider a "good interest rate?" I get .5% (yes that's right, one half of one percent) at my credit union. That's good?"
You should find another financial institution. I get 3.5% on a fairly conventional, hum-drum savings account.
Re: What do you consider a "good interest rate?" I get .5% (yes that's right, one half of one percent) at my credit union. That's good?
It has not been much missed.My retired parents, who rely heavily on savings interest for income, miss it quite a bit.
Um, back when the government set deposit interest rates it set them LOWER than the market rate.
Markets allocate available capital to achieve the greatest return at the lowest risk. The greater the available capital, the lower the interest rates and the greater the acceptable risk.
The combination of lots of available capital, relatively low interest rates, growing demand for housing and governmental pressure to loan to high risk borrowers "nudged" the market toward higher risk exposures.
Markets correct when excesses occur. In the process, those on the margin suffer. While there was substantial pressure on the financial institutions to loan to those who represented higher risk, no one forced or coerced the borrowers to take the excessive risks involved in zero-down mortgages, interest only loans, etc. The idea that they should be protected from their folly at the expense of the rest of us is ludicrous. Let the markets correct.
In partial defense of those who took the unreasonable risks, their risk was less than buying a lottery ticket, though the amount wagered was larger.
Within three hours of posting this entry...
http://meganmcardle.theatlantic.com/archives/2008/04/reading_is_fundamental.php#comments
...there were 54 (mostly incredulous and resentful) comments.
Within three hours of posting the current, wonky, entry there are only 5.
I guess Megan's right after all. No one reads articles on policy.
liberalrob: "What do you consider a "good interest rate?" I get .5% (yes that's right, one half of one percent) at my credit union. That's good?"
Scott: You should find another financial institution. I get 3.5% on a fairly conventional, hum-drum savings account.
Ahhh, but you see, unlike your greedy capitalist robber-baron commercial bank, his money is in a place with the word "union" in it's name! It MUST be looking out for the working man!
Conservatives?
The problem here is that we are a nation with millions of college graduates who are financial idiots, who can't manage a simple budget, and whose understanding of economics is that whatever you own (stock, houses) only goes up in price.
Let's see, now. Who runs all those colleges?
Liberalrob, that is perhaps the most arrogant and yet uninformed commenter response I've seen in a long time. Bravo.
I think both the liberrob and Megan's posts speak for themselves, so I won't go deep on them. Megan's point, that looking back and thinking of a regulatory scheme that would have avoided the current problems yet not outweighed the costs and have been politically desirable is much harder than it sounds, should be well taken. Maybe it's that chunk of libertarian in me, as in Megan, but I just kind of accept that as part of reality. You can't foresee ever calamity, and trying to prevent EVERYTHING creates disaster rather than avoids it.
But, like others, I was amused and baffled by this comment from Liberalrob, "what do you consider a "good interest rate?" I get .5% (yes that's right, one half of one percent) at my credit union."
Now, I get a miserable rate as well, but I use Bank of America, and I get a sadistic pleasure when I see them charge me a service fee on my checking account. The pain feels so good. Is that wrong?
Anyway, I bet Liberalrob gets a different kind of pleasure when banking at an institution called a "credit union." If I had to wager, I'd say it's affiliated with....nurses? No, must be teachers.
In any event, that's his choice. Smarter people than both of us use the free market and put their money where a combination of the best service and best rates can be had. I hear the online banks are outstanding with reimbursed ATM fees, free checking, and extremely high interest rates.
These types of banks, which didn't exist even a decade ago, are a testament to how versatile and inventive our system is.
The place to lay the blame is on the Federal Reserve! This is a government institution.
If you make credit much cheaper than the free market would do on it's own, you will end up with lots of malinvestments and lots and lots of bad debt. What the hell do people expect to happen when debt is made to be dirt cheap?
Wow. liberalrob. Wow. If only you were half as smart as you think you are you wouldn't completely miss the point of every post and then show off that ignorance with arrogant comments.
Rising to the level of half as smart as you think you are would also enable you to comparison shop for banking services and not, as others have pointed out, opt for an insanely low savings rate and then complain that it's the government's fault for not setting it for everyone.
Reading your comments is like journeying through the mind of an idiot in the depths of an ether binge.
Actually Megan you make the point that mortgage brokers are licensed by the state and this problem can be chased back down to the state level. That's all fine and good but a number of states started to deal with the problem of sub prime loans and the Feds stepped in and stopped them.
http://www.slate.com/id/2182709/
Instead of copying and pasting the article I suggest you give it a quick read. The summary is this - A number of states start passing laws dealing with predatory lending. Players in the secondary market ask the Feds to step and simply nullify state laws (Georgia, New Jersey and New Mexico).
"While the banks' legal arguments were thin, the OCC issued regulations in early 2004 nullifying the state laws as they applied to national banks."
Had a strict federalist approach been taken, we might have several more experiments on how to deal with the problem.
Megan, there were a LOT of people around in the early 2000s who realized something was seriously effed up. I'm no financial genius, but when I realized a fixed-rate was roughly 2-3 percentage points below the historical average, Greenspan coming out lauding ARMs to the skies made absolutely no sense to me. And now of course the old man is now running around wringing his hands and saying "hoocodanone?" and that None Of It Was His Fault.
Look--when you are in a Very Official Position and you do NOT put oversight into play, "trusting in the Market", you are STILL giving a message to the world: You are saying that "all bets are off, no regulation is necessary, and you guys can do whatever you like. Forget prudence and foresight."
So Greenspan's commentary about how he wasn't giving any signals to the market is just all horsefeathers. And he bloody well knows it--he's just trying to scrape the egg off his face and blame someone else for the debacle.
JP, I think the reason few people commented is that the post is a drop dead gorgeous argument. You now they say 'Bush lied, people died.' Well you know he also said that home ownership was up and that was good; where's your party spirit! This time though we can't blame the dumbasses at the CIA; like in Pogo paraphrased, 'The dumbass is us.' Along this line it would be nice to say, 'How could the investment banks not have known there were weapons of mass destruction in the mortgage market?' except that some did. Goldman Sachs made $5-6 billion last year betting on decline in the associated bonds; meanwhile UBS of gold bug gnome Swiss fame lost, oh, a cool $35 billion. Still and all the lack of intelligence about the underlying value of the assets is sobering. Re: regulation, what would the bill be entitled: The 2008 Omnibus Financial Dogma Prohibiting The Slamming of Forks in Your Eyeballs.
One technical correction: Citi no longer has "in-house" mutual funds. Has not had them for a couple of years now.
Larger point. This crisis -- so far -- feels no worse than the 2000-01 correction except that then everyone was arguing there was no recession at this point in the cycle.
Short summary of events so far: Wall Street booms and busts happen every five years or so. They are driven by fear and greed in an eternal circle. The tough part of the cycle is that better regulations decrease the fear and increase the greed by providing the illusion of a lack of risk. Ultimately the busts still happen.
This time the greed was very widespread and obvious to anyone who looked -- people were paying too much for houses without asking any questions. In fact, they thought you were crazy if you questioned them about paying such absurd prices. Meanwhile, Wall Street had excess liquidity to lend, so they lent it.
Subprime may have been the pin that pricked the bubble, but greed had moved well beyond houses to the private equity and broader fixed income markets. Even today the commercial paper market is still all out of wack (it has been for more than a month). Bridge loans for private equity deals have become pier loans and much more is occurring under the surface. In short, the fixed income market is frozen up.
I had dinner Thursday night with the head of one of Citi's units who said their fixed income traders still have nothing to do all day other than plan their post-trading careers. This was three trading days ago.
Even in the housing market the real issue is not bad subprime loans but underwater mortgages. That is something the Feds cannot fix unless they dose the economy with a inflation to the tune of 10 percent a year or more.
Yes, Ezra is right that Republicans may get the blame -- but the more important point is that neither party, indeed no politicians, have enough understanding ans wisdom to prevent these economic bumps along the road.
And, yes, we will recover.
I believe that a lot of the regulation of the mortgage industry is actually done by the states.
So, in the case of California, with its lo-doc/no-doc problem, the poor regulation should be partially laid at the feet of the party in charge of making laws to regulate the mortgage industry there....that would be the Dems.
I don't know who's in charge in FL, probably the GOP. So its seems like a bipartisan problem.
If we want to blame low rates at the Fed, didn't Greenspan get appointed, confirmed, and re-confirmed by both parties?
p.s. The Fed is in the inflation busting and "full" employment business, not in the bubble busting business. Maybe they should be, but that is a very large kettle of fish.
"In some sense, this obviously could have been prevented by regulation; we could have outlawed all mortgages below Alt-A, for example, and jacked up capital requirements to fifty percent."
Someone wanted to raise FHA down payment requirements from 3% to 3.5% as part of the current housing bill and Barney Frank opposed this. This is the liberal problem in microcosm: they want more regulation, but they oppose many of the kinds of regulation that would have limited the housing boom (and the corresponding bust).
Although I more share the political and economic viewpoints of his detractors, I think liberalrob's points are excellent ones. On the other hand, I do enjoy Megan's vacillations on meaning since I think they better capture an authentic thought process. I guess I'm not representative of the reading audience, though, since I probably won't be part of it much longer (felt a jump-the-shark moment accumulating of late).
How about the Georgist convenient narrative, that the root of teh problem is land speculation (called real estate speculation in polite company, but that confuses land with buildings)? That not only has something worthwhile to offer the discussion, but something close to a solution: tax the value of land, and cut other taxes, so we won't have speculative booms and then busts in real estate.
You spend a lot of time attacking my intelligence and none addressing my points. In short, your comment is valueless.
Rising to a level of half as smart as I know I am (again with the insults?) would enable you to understand that savings interest rates are based on Fed funds rates, which have been continually slashed year over year in an effort to "fight inflation." 3.5% rates are only available through long-term CD's or high-minimum-balance accounts these days; tying up your money for years to get a dinky return is silly, as is then whining about Americans' low savings rates.
We're so screwed. No one gives a damn, and the only people who could change that don't give a damn either.
Idiocracy is totally derivative of Douglas Adams. Just thought I'd throw that out there. Not that anyone cares.
Fred:
The laws that would have prevented the mortgage mess would have had to have been passed long before November 2006 and the Republicans controlled both the House and Senate before Nov. 2006.
Ed Reid:
While there was substantial pressure on the financial institutions to loan to those who represented higher risk, no one forced or coerced the borrowers to take the excessive risks involved in zero-down mortgages, interest only loans, etc. The idea that they should be protected from their folly at the expense of the rest of us is ludicrous. Let the markets correct.
The Fed sure did step aside and let the markets "correct" the Bear Stearns fiasco, didn't it? Oh, wait, they didn't. I take it that you think the Fed made the wrong move in bailing out Big Bear?
Not Liberal Bob:
Reading your comments is like journeying through the mind of an idiot in the depths of an ether binge.
Ether binge? Who the hell makes these kinds of stupid jokes? I might kill you tonight.
Someone contact Barney Frank and tell him he is now "Liberals," as in all liberals. And because Frank once opposed an FHA downpayment requirement (for unstated reasons), all liberals now "oppose many kinds of regulation that would have limited the housing boom."
It's interesting and yet not surprising that conservatives who are used to being a bloc that all votes one way cannot conceive of their philosophical opposites not being such a bloc.
The fact that the peanut gallery focused on my naivete' at having a credit union account that only returns .5% and almost completely ignored the issue at hand (Megan's disagreement with Ezra Klein and the remaining 90% of my comment) also is worth noting. Most blog commenters are more interested in ranking contests and slagging off the outsider than in actually having a substantial discussion.
Speaking of having one's soul crushed bit by bit...
Guys, I love you all. Please don't call each other idiots. It makes me cry.
"Someone contact Barney Frank and tell him he is now "Liberals," as in all liberals."
Oh, don't do that. Barney Frank's actually one of the smarter and more reasonable liberals out there. Which only sharpens the point, really: even a smart liberal is against a policy that (I'm sure he realizes) would reduce the risk of another real estate bubble, because (he also realizes) it would make it harder for poor people to own a home.
That's the crux of the regulatory dilemma. Most regulations that would prevent another real estate bubble would also put homeownership out of reach for lower-income and other marginal borrowers. This would go against the long-running bipartisan consensus that the higher the percentage of Americans who are homeowners, the better.
But financial regulation is usually better at preventing the last crisis than the next one. - MM
It is better to prevent the last crisis from occurring again than to have the same crisis occur over and over again (see: the late 1800s). At least nowadays we force our financial wizards to come up with ever more creative ways to blow trillion-dollar stakes and plunge the world into recession.
That leaves that other talismanic incantation: "Regulate subprime markets". But what does this mean?...More to the point, how would you have generated the political will to do any of these things in, say, 2004?
It's fair to ask just what could have been done, regualation-wise, to prevent the subprime meltdown. But it's not fair to ask how one could have found the political will to do so. The fact that the political will to regulate was absent in the late '90s and 2000s (was, in fact, deliberately destroyed) is precisely the substance of the pro-regulatory critique. Saying regulation couldn't have prevented the meltdown because there was no political will to regulate is just question-begging, in the proper sense of the term.
Megan: Don't cry ... you care too much.
Yes, greed.
The only way a free society can survive (i.e., without a lot of the oppressive regulation so many of you are decrying) is if the individuals in it take personal responsibility for behaving ethically. That is, we need to behave better than the rules and laws require.
Anybody willing to go first?
I would think the major problem is giving loans to unqualified people, and that gets compounded by securitization when the loans are packaged and sold by Wall Street into all corners of the economic system.
But securitization is nothing more than risk diversification.
The underlying problem is the quality of the loans. That seems like not such a hard thing to fix.
Thus you don't say, "Oh shame on the Fed for low rates and too much liquidity".
You don't say, "Shame on Wall Street for securitization".
Those things are not bad of themselves assuming everyone is being honest. The problem is at the mortgage broker/bank lending level.
We:
1) Allowed people to get loans without documenting income.
2) Allowed people to get loans for homes that exceeded their income level.
3) Allowed (until some recent law changes) people to manipulate FICO scores by up to 300 points by credit piggy backing.
4) Allowed illegals to get home loans under special programs that looked at "alternative" credit evaluations, like family support and ethnic propensity to pay back.
5) Allowed lenders to put people into ARMS or loans with teaser rates that would ultimately end up at higher rates impossible to support given the stated (or unstated) income.
The problem with fixing those things listed is that it impacts lower income people the most and Demorcrats are all about "the little guy" and some Republicans (like Bush) thought that pushing the ownership society would help prove to the critics that they do in fact care about lower income Americans.
Clearly, some people can't own homes and I say this as a person in that status. The only way to prevent the type of defaults that then cause destruction of securitization valuation models is to have some minimal levels of credit quality.
Make people prove income. Match loan size to FICO score. Make people pay higher downpayments or post collateral based on credit quality. Also, make it easy for Wall Street to put back loans to the originators if the documentation proves faulty. Attach criminal penalties.
Yes, that means people with bad credit can't own homes and that is how it should be. You offset by creating programs for low income folks that offer incentives and bonuses for saving.
(As for bank interest rates, see ING or HSBC Direct or a brokerage account, all of which pay better on your free cash. Also, to those taking shots at Credit Unions... generally today many have no relation to "unions". A lot of them are based on company or geographic region and are virtually no different than a commercial bank).
KSinMA,
Greed is an aspect of self-interest, but so is prudence. Even if absolutely no regulatory changes are made, the mortgage business model will be changed regardless, because of the self-interested prudence of downstream actors. Institutional buyers of complex mortgage-backed securities will demand more assurances as to their quality; this will likely lead to all sorts of changes upstream. For example, those institutional investors might demand that credit rating agencies have some skin in the game, by accepting part of their fees in the riskiest tranche of the product; those rating agencies may in turn scrutinize the underlying mortgages more closely; that may lead to securitizers demanding that mortgage issuers have some skin in the game -- perhaps by deferring a significant part of their compensation for a few years and applying a big haircut to it if more than a certain percentage of the mortgages they sell default.
Finn,
Your suggestions are spot on, except the ARM's do have a place in mortgage financing. If interest rates are historically high, its wiser to get an ARM than a fixed rate mortgage. We have not seen that situation in the last 20 years or so, but it could be happening again soon!
I really hate teaser rates in general, too. Those seem like cheap ploys, but can we really "ban" them?
Re: Allowed (until some recent law changes) people to manipulate FICO scores by up to 300 points by credit piggy backing.
A small but important quibble: the government has not part in FICO scoring. FICO itself permitted the tactic you note, and eventually eliminated it. However, given that FICO scores are often enough negatively impacted by erroneous or misinterpretted information I don't see that allowing the consummer a tool or two on his behalf is a bad thing.
Re: Allowed illegals to get home loans under special programs that looked at "alternative" credit evaluations, like family support and ethnic propensity to pay back.
Setting aside the "iilegal alien" issue, what's wrong with reckoning personal loans toward one's credit record?
Re: Also, make it easy for Wall Street to put back loans to the originators if the documentation proves faulty.
It actually is fairly easy. The big banks (I work for one) can enforce repurchase on the seller if the loan proves defective in any way during the first six months (sometimes longer). The problem now is that many of the sellers are out of business, and quite a few ended up that way because they did have to buy back a lot of bad loans.
Roy Edroso on Megan McArdle:
"It's a good thing she hasn't got a job better suited to her talents, such as coal-mining: were the canary in her mine to drop dead, she'd probably just complain that she missed its singing and ask for a heartier one to be sent down."
My response: Preventing fraud is not "regulation".
Why is it that there is some fool always around to misinterpret the causes of situations like this? This crisis has more to do with FDR than with any repeal of laws set up by him. He's the bastard who made our system into a free floating fiat monetary system. That is the cause of our problems here.
The same kind of stock jobbing, asset inflating mania has happened over and over. It's connected to monetary inflation, not deregulation. It's the monetary inflation that makes everyone think business is better than it is and makes them take risking investments to get in on the boom.
The boom wouldn't happen if anyone would listen to the Austrians, who by the way predicted this crap unlike the geniuses who are tracing this to other factors.
liberalrob,
I am an investigative reporter (MSM) who was in frequent touch with Kerry's economic team during the 04 race. I can assure you that much of their economic platform was predicated on a robust continuation of the carry trade. Everything else was politics.
Your politics are your own and I do not, as some here do, seek to discredit your views or beliefs. But the thought that a Dem nominee would go full-bore at sub-prime during a housing boom....non-starter. The Dems are an afterthought in a POTUS election without 95-98% of the black vote (which is about 13% of the populace, maybe slightly more in NY and Ca.). They dont get that when they go at lower credit borrowers.
as to glass-seagall: I think its repeal was awful. It allowed commercial banks a massively disproportinate advantage capital-wise and led them to use their balance sheets to do things like warehouse CDOs and hold 60-70bn worth of mortgage credit at a time.
investment banks, back in the 80s and 90s, didnt do that (for all their flaws and sins).
Liberalrob,
There are quite a few on-line banks that offer 3% and up on regular, no-minimum-balance savings accounts. I have one and it's as easy as falling off a log. Beats the hell out of the .5% I was getting at my brick-and-mortar bank.
Liberalrob,
There are quite a few on-line banks that offer 3% and up on regular, no-minimum-balance savings accounts. I have one and it's as easy as falling off a log. Beats the hell out of the .5% I was getting at my brick-and-mortar bank.
But securitization is nothing more than risk diversification. The underlying problem is the quality of the loans. That seems like not such a hard thing to fix.
Um, no. The problem that's threatening the international credit system and potentially plunging the world into recession isn't that too many people got mortgages who shouldn't. That would constitute a downturn in the housing market, nothing more. The problem is that the securitization of those mortgages, instead of diversifying risks, actually multiplied them by chopping up bad loans and mixing them in with the good ones, like brains in cattle feed. Then they chopped up those securities and mixed them in with other ones and reissued those. And so on. And, finally, they pretended that the whole mix was one hundred percent pure healthy oats. So now not only does the rising default rate turn all those supposedly good securities to crap; it also means people can't even trust the securities that actually don't have any poison mortgages in them, because they've been told they're all the same.
The subprime situation is a big problem, but it's not the biggest problem. The biggest problem is deliberate nontransparency in the securities industry.
Perhaps you're only a quarter as smart as you think you are. Slashing rates to fight inflation? Please tell me you were being ironic.
For the record, I rarely agree with MMcA but she is right about this.
Sigh....
The problem is the arficially suppressed rates of short-term interest. Cheap credit corrupts everything. It destroys the incentive to actually save, it destroys lending standards, it starves productive enterprises of the needed capital for maintenance and expansion while encouraging the expansion of nonproductive activities.
Changing the regulations is a bandaid at best.
"Bear needed the balance sheet of a big commercial operation, JP Morgan, to bail it out."
Actually Bear needed American taxpayers and the big, bad government to put up the collateral to allow JP Morgan to bail it out because it was "too big to fail."
If these speculators are too big to fail, they should be subject to government regulations.
As a taxpayer, I'd rather pay a little for prevention up front than pay a lot with these bailouts.
Mmm, Brooksfoe, you know I respect your analyses, but I think you're wrong here. The problem isn't that bad mortgages got mixed up in the good ones; that's the problem that securitization solves, by using the law of large numbers to smooth local downturns. The problem was that they mispriced the bad ones. And the bad ones were mispriced in part because people misreprested things--either borrowers fudging their income, or mortgage brokers misrepresenting costs. It's not true that the securities are all the same; the problem is that the permutations down the chain introduce pricing uncertainty at each step, not that there's no way to differentiate between the tranches of an MBS.
One thing I haven't heard is what was up with the bond rating agencies. It seems like they are the ones who facilitated the whole thing, by incorrectly assessing the risk of the underlying mortgages.
Don't they bear responsibility? Even liability? How have they escaped scrutiny?
Mikey:
I don't trust any bank I can't drive up to.
For those who are interested, my credit union began as the Texas Instruments Credit Union. Then it became Texins, and now it's called Texans. I only really maintain an account there because credit unions historically have had good rates for home and auto loans, and I might need one of those some day.
I also maintain an account at Chase.
mishu
How about 3/8ths. Do you deny rates have been slashed, for whatever reason? And that those cuts have directly led to lower savings interest rates being offered? That's my main point on that subject.
tt quick:
That's great that you were an investigative reporter; who for? That's kind of important. If you're going to argue from your own authority you need to establish that authority. So, are you contending that the USA Today story I linked was inaccurate? Or are you contending that Kerry was just "playing politics?" (Who doesn't? But then again, what's your evidence that he wasn't making a serious policy proposal? Besides the fact that he was a Democrat who windsurfed.)
Hey, we're getting close to 50 comments now- without a link from Greenwald. Not bad.
Wow, liberalrob makes a thoughtful, succinct, and devestating critique of not just Megan's willful ignorance, but of libertarian thought altogether. And the response? "Liberalrob is a dummy!" Yet more proof of the utter vacuousness of conservatism.
Much of the subprime issue was addressed at the state level, recognizing the potential harm of subprime loans.
See:
State Anti-Predatory Laws Models For Federal Regulation
http://realtytimes.com/rtpages/20060228_predatory.htm
But the Treasury Dept's Comptroller of the Currency successfully limted state regulation, after prompting by banking industry.
http://econospeak.blogspot.com/2008/01/regulatory-neglect-and-subprime.html
Good overview here:
HOW THE FEDS STOPPED THE STATES FROM AVERTING THE LENDING MESS.
http://www.slate.com/id/2182709/
(Note, despite claims of thin legal foundation, the Supreme Court eventually backed the Feds,
http://www.iht.com/articles/2007/04/18/news/banks.php
I don't trust any bank I can't drive up to.
www.bankrate.com: Capital One appears to offer 3% on MMAs without minimum balance, 3.75% on $10K and above. I need to check what my WaMu savings is paying now, was just around 4% a couple months ago. Both are brick-and-mortar institutions with numerous branches here in TX.
The market has been very competitive for a while, online-only banks don't seem to have a big edge there.
A very valid question.
I am afraid I cannot reveal my identity, as my employer essentially forbids blog posting, and/or discussion about work-product away from sanctioned events or our online "chats." I always (well, almost)comply--I need the work-- but I enjoy this blog and thought it was worth the risk.
I dont have interest in Kerry's windsurfing or his party affiliation, nor yours. Everyone is entitled to their hobbies and fun.
I contend that the USAT story was not false, as such, but a flight of fancy, designed to stake a claim on a moral highground.
Based on my discussions with jason Furman and contact with the likes of his senior Wall STreet backers, they had zero interest in taking away the housing party's punchbowl. They were very, very happy to inherit a housing mania, for many reasons, all of which should be apparent to you.
it's as simple as that. The GOP obviously does the same thing in election cycles--make plausible policy claims that they have no chance of enacting--so there is no way this should be taken as a slam against Kerry or his backers, you included.
"...savings interest rates are based on Fed funds rates, which have been continually slashed year over year in an effort to 'fight inflation.'"
Year after year? Is that true? It wasn't too long ago that the Fed Funds target was in the 1% range. My recollection is that the Fed didn't start dropping the Fed Funds target rate until about a year ago.
At any rate, just a minor econ 101 point that isn't really related to this discussion but should be pointed out: cutting the Fed Funds target rate isn't an inflation fighting move. It's actually a money supply loosening move that will increase inflation and is supposed to reduce unemployment.
While I think liberalrob is 85% correct, his mistaken belife that government regulation of interest rates meant higher rates for depositors reveals the key flaw in his argument.
When government regulates an industry, it almost always ends up regultating for the benifit of the industry rather than the public.
Megan,
Bravo, your best post ever and a welcome infusion of economic literacy.
Banks can always adopt underwriting standards that guarantee they'll get their money back: the old tried and true 20% down with a monthly payment that is less than 28% of documented gross income will do nicely. (Under this standard, both Alt-A and subprime mortgages become extinct.) Unfortunately, mortgages with little or no credit risk generate returns that are too small to compensate for the classic bank interest rate risk of "borrowing short" and "lending long". The failure of all-prime mortgage lending as a business model is the reason we no longer have an S&L industry.
Mortgage based SIVs updated the S&L model by investing in mortgages with some credit risk rather than credit risk free agency mbs. The mortgages were still high grade (typically AA or better) and mostly free of interest rate risk -- usually high grade floating rate tranches wherein the underlying loans were subject to prepayment penalties. These short duration assets were funded in the CP market and the net duration of the vehicles was approximately zero.
This model failed when declining house values left these mortgages undercollateralized and no longer worthy of their AA rating. In price terms par bonds were quickly re-marked to 80 or less. The result: CP investors refused to roll their paper, forcing liquidation of the SIV portfolios at a substantial loss. The rest, as they say, is history. The only regulation that could have have "foreclosed" this calamitous outcome would have been the imposition of underwriting standards that prohibit Alt-A and subprime mortgages altogether. But this still leaves banks inclined to focus on residential mortgage lending without a viable business model.
It is regulation that got us in this mess to begin with. Not with malice or forethought, just the old iron law of of unintended consequences and perverse incentives. And all of it no doubt well meaning.
At the heart of it all is the FDIC. As long as you can insure a bank deposit (up to 100 thousand) at no cost to the insured, there is no incentive to the insured to minimize the risk. Obviously we need a deposit insurance system to provide stability to the banking system. But what is needed is risk pricing of the insurance to the depositor. Then depositors can decide to seek a higher return (interest rate) versus a higher insurance charge (the riskier the bank). Although not a perfect solution, none is, insurance actuaries rating the risk of each deposit taking institution will be a far greater guarantee of solvency, credit worthiness and true equity/capitalization than any of the proposed ideas being bandied about now. Particularly if private deposit insurance were to be available above the FDIC insured limits. And the ability to maintain deposits in foreign currencies as well as the USD.
The Bear did not go down because it did not have the reserves required, it did and more. It is that the reserves were invested in a financial inventory that was marked down in value over night (mark to market) and therefore that collateral was no longer sufficient to cover the loans it was pledged against. Insurance actuaries reviewing such portfolios of investments and the like would rate the risk and the premiums to cover the risk would bring in the market discipline to maintain the solvency needed in the capital markets. Again this is not by any means the perfect solution, but bubbles and the subsequent crashes result from the no apparent pain or fear of loss while the bubble is expanding. Transparent risk insurance puts the fear of God in the speculator and foolish investors and provides a cautionary warning to the rest.
Sigh. This is exactly like the discussion about who was right/wrong about the invasion of Iraq.
The people from two to three years ago warning us about the current mess point their fingers mainly in the same direction, or samll set of directions. The people from two to three years ago who were making rosy predictions about the housing and credit markets and who were subsequently blindsided are - you guessed it - pointing their fingers in a completely different direction. Namely: (of course) it's the fault of liberals and over-regulation.
Why should we believe them, given their track record? Is there anyone from 2005/2006 who was predicting the dire consequences of over-regulation? If so, I'll at least listen to them.
But not to the likes of Greenspan, et al.
ScentOfViolets, it's amazing, I was thinking the exact same thing. As with the Iraq war, the disaster was foreseeable and foreseen. Even by a non-specialist like me.
When a disaster can be foreseen, and is foreseen, something can be done about it before it happens.
Next on the list of "surprise" catastrophes: global warming.
"Heavens! With hindsight, we would have done things differently, but who could have known back in 2008?"
Re: Someone wanted to raise FHA down payment requirements from 3% to 3.5% as part of the current housing bill and Barney Frank opposed this. This is the liberal problem in microcosm: they want more regulation, but they oppose many of the kinds of regulation that would have limited the housing boom (and the corresponding bust).
FHA mortgages are not the problem. For one thing, the FHA has always been very insistent that borrowers document their income and assets fully, it follows strict income-to-payment standards in determining who can afford what size loan, and it also subjects property appraisals to minute scrutiny. Had borrowers with impaired or minimal downpayments stuck with the FHA (which was created to help just those people) rather than rushing into subprimes, this mess would be far less nasty than it is.
Megan, it's not just that lot of people had dodgy debts. It's that the banks took loads of those dodgy debts and then, through the magic of financial engineering, created all sorts of things that had "AAA!" slapped on them and sold off to investors.
Problem was, nobody really cared if that risk analysis was correct. The banks certainly didn't, because they had sold everything off, taking a nice little chunk of commissions in the process, the rating agencies didn't care, because they kept getting more business, and the investors didn't care, because they had a portfolio stuffed full of good AAA stuff which the rating agencies had gen-yoo-ine-ly told them was as safe as a stodgy gov't bond making much less. Banks played on their reputation as being stodgy and wise entities acting virtuously for the sake of their customers, when the real dope was they couldn't care less as long as they shoved the stuff out the door and got $$$ for it.
I blame the borrowers less than the lenders. Yeah, the average lender was far too willing to listen to a smooth-talking broker/mortgage seller who told him he could live the life of his dreams....and far too willing to yank supposed equity out said house via HELOCs etc. But the guys sitting on the other side of the table were using that reputation for fiduciary prudence which had been built up, year by year, and had no doubts about using that reputation to get the borrower to "trust them".
So yeah, everything go--let the banks fail--let the investors go down, let the rating agencies crash.....pain is the only way certain organisms learn how to be prudent, unfortunately.
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