So no responsibility for not recognizing the problem and not doing anythng about it for almost eight years? I'm not an expert but blaming the current meltdown entirely on ... Clinton seems a stretch to me.
But I don't blame it on Clinton. I think that the regulatory steps taken under the Clinton administration were entirely appropriate. To put it more boldly, I don't think that this represents a failure of prospective regulation.
I hope that this will result in deep changes to our regulatory system, starting with unifying the diverse bank regulatory body, and giving them a stronger mandate to watch systemic risk like a hawk. I hope the GSEs will be broken up, stripped of their government guarantee, and regulated like other companies that do the same thing. I hope the central bank will pay more attention to inflation, and less to unemployment.
But that is retrospective. What can I say that Bush, or Clinton, or anyone else, should have done, knowing what they did at the time? I can demand that they be omniscient, but since I'm not willing to hold myself to that standard (nor, I expect, is Andrew), that hardly seems fair.
There are a couple of problems that I don't have answers to yet:
- Should the Fed watch asset price bubbles? It's obviously tempting to give a glib yes, but there are deep problems with this. The Fed already has a lot on its plate; adding asset prices would vastly multiply the complexity. And it's not clear we'd be happy with the results. If the Fed is too conservative, it will tamp down growth prophylactically. I'm not confident that regulators can correctly identify the moment that we enter an asset price bubble. And asset price bubbles are really, really hard to pop. I refer you to John Kenneth Galbraith's description of the government's attempts to shut down the 1929 boom.
- How should the Federal Reserve have dealt with the river of money flowing into American markets from central banks and savers abroad? This was the primary culprit in the credit expansion, not the Fed--indeed, that's why the yield curve got so funny looking at the end.
- What standards should we use for evaluating derivatives? Derivatives don't just create risk; they can also lower it, by allowing firms to hedge. When Robert Shiller tells me that overall they're a good thing for the financial system, I'm inclined to listen.
- Is mark-to-market accounting a good idea? A lot of the problem can be traced to the practice of marking all assets to market value at the end of the day. This has advantages, in that it gives investors a better idea of the breakup value of the firm. But it can also touch off downward spirals--they open up balance sheet holes that create ratings downgrades and force asset sales, which further depresses the value of those assets and opens up similar holes at other firms.
- Keep Fannie Mae and Freddie Mac out of risky mortgages, and give OFHEO some teeth. Bush and several Republicans tried, and failed, to do this. My preferred solution, an explicit strip of the government guarantee and a supervised breakup, wouldn't even have gotten on the radar. Fannie and Freddie were politically powerful, as were voters who wanted to buy houses.
- Regulate mortgage brokers at the federal level. Given the way mortgage funds now flow across state lines, this made sense. But the state governors would have screamed bloody murder. Moreover, no one knew about the fraud when it would have helped--i.e., before most of it happened.
- Mandate 20% down payments. Political suicide. Affluent people would continue to borrow downpayments in private family loans, while the poor were shut out of the housing market. Poor neighborhoods would have been devastated by the credit cutoff. House prices would have dropped sharply everywhere.
- Change regulatory standards to take more account of small-probability, devastating systemic risk. Nassim Taleb has been talking about this for the last few years. But I didn't hear more than academic interest in this until mid-2007. Most people on the Street really believed that they had gotten better at assessing credit risk.
- Unify the bank regulators, including the SEC, into one agency. At least some of this crisis might be traced to the fact that the regional banks who originated many of the bad loans were often regulated by a different body from the investment banks who bought them. It might have been done, I suppose. But each of those agencies has powerful constituencies among their employees, and the firms they regulate. Moreover, the transition process would have involved some ugly internicene warfare that probably would have eroded regulatory effectiveness in the short run.
- Mandate contingency plans for the dissolution of large firms, and other unlikely but devastating scenarios. If people had some certainty about the likely outcome of an insolvency, the panic selling wouldn't be so rampant, and people would be more willing to loan money, albeit at a discount. But again, I didn't hear anyone talking about this in, say, 2006. I certainly didn't think of it. Is it reasonable to say that this should have been utmost on the mind of Bush or his advisors, while other big priorities, like trade deals, loomed large?
- Make subprime loans illegal. As long as most subprime borrowers are still making their payments, I can't endorse cutting them off to protect the fools. Moreover, this would simply not have been possible, no matter who controlled congress or the presidency. Cutting off subprime loans would have prevented more people from buying homes. The politics of it are terrible.
- Make option ARMs or negative amortization loans illegal. Option ARMs are debateable-they're actually useful for people who have uneven income flows, like, er, a lot of journalists. But clearly they were abused, and negative amortization loans are nuts. However, these exotic instruments are only a fraction of the toxic subprime loans. They appeared mostly late in the process, when lenders were scraping the bottom of the barrel to keep the boom going.
- Change the way that these securities were accounted for. Most risk models for ABS and MBS were focused on prepayment risk, not default risk, which was assumed to be fairly well known. This assumes a rather stunning level of prescience on the part of regulators or legislators.
- Force banks to keep some amount, say 10% of the loans they originated. Spain does this, and its housing market is even more bubbleicious than ours was, believe it or not. It might have made the banks more secure. But there are good reasons to want banks, especially small banks, to have the flexibility to match the durations of their asset portfolios to those of their liabilities. When interest rates skyrocketed in the early eighties, banks were stuck with long-term mortgages at low rates, but forced to offer high interest rates on savings accounts in order to keep business. The result was, ultimately, the S&L crisis. And again, while there may have been someone proposing this somewhere, I didn't see a lot of people talking about it in 2003, when it really might have helped.
- Repealing Gramm-Leach-Bliley, or at least the provisions that repealed Glass-Steagall's ban on commercial banks entering other lines of financial business. If this were part of the problem, it would be the commercial banks, not the investment banks, that were in trouble.
- Lowering CEO pay. Whaaaaaa? If Dick Fuld had been paid a dollar a year, we'd be in exactly the same mess. Probably worse, because what kind of CEO do you get for a dollar a year?
- Raising the Fed Funds rate The MBS money was long money, not overnight funds. And when a bubble is truly going, raising rates may just attract more long money, without deterring speculators who are expecting double-digit annual returns.
- Requiring better disclosure of loan terms Disclosure of loan terms is already quite exhaustive, including a term sheet right on top that provides a congressionally mandated summary. You can't make people read things, and the extra disclosure you mandate goes into the "fine print" that people claim they can't read. Moreover, the fundamental problem for most borrowers are things that aren't hard for buyers to understand, like "I have an adjustable rate mortgage"; "Interest rates can go up"; and "My housing payment should not be two-thirds of my gross income".
- Changed the neo-liberal "culture" The president and congress are not the parents of Wall Street, and believe me, bankers do not look towards Washington for moral guidance. The "Miasma Theory" of political influence is the last refuge of partisans who know they are full of it.
The point is, given what they could reasonably have known then, did regulators act unreasonably? Did legislators ignore politically feasible policy options? I don't see it.
But if you are looking to place regulatory blame, whatever changes you'd care to point to happened on Clinton's watch, not Bush's. You cannot have it both ways--hailing the Clinton genius at economic management (and implying that Obama will bring back those halcyon days), and then claiming that Bush should have trailed around undoing all his work. You most certainly cannot explicitly claim, as Obama did in his speech, that this crisis is the result of the Bush administration's deregulation of the financial markets:
The challenges facing our financial system today are more evidence that too many folks in Washington and on Wall Street weren't minding the store. Eight years of policies that have shredded consumer protections, loosened oversight and regulation, and encouraged outsized bonuses to CEOs while ignoring middle-class Americans have brought us to the most serious financial crisis since the Great Depression.
This is flat out untrue. And I know that Barack Obama is smart, and well-informed, enough to know it.
Update: I should note another thing regulators could have done, which is required more reserves. It's hard to do this when banks are in trouble, since if they had a lot of cash, they wouldn't be in trouble. But while it's now clear that we should do so going forward, I'm hard pressed to say that I could have predicted it then. One reason debt-to-equity ratios are so high now is that toxic securities have caused balance sheets to collapse. Moreover, while this would have let the Fed off the hook, somewhat, it's hard to see how lower debt-to-equity ratios could actually have prevented most of this. As far as I can tell, the scale of the collapse is so epic that unless regulators were willing to really make the banks radically delever (remembering that the resulting credit contraction would have had negative economic effects--the ones we're seeing now), it still would have taken down a lot of firms.
"This is flat out untrue. And I know that Barack Obama is smart, and well-informed, enough to know it."
Of course he is. And of course you're smart and well-informed enough to know that giving the text of your post as a speech would be incredibly derided by pundits looking for "action" and set him up to be painted even more as an effete wishy-washy liberal.
Arguments that need pages to be made and still often can't be understood by most people don't make for soundbites, and unfortunately that's the culture in which one has to win an election.
Megan, great post as usual, and I always enjoy your clear-headed and patient explanations. So for most of us, this was a valuable post.
However, while it may make sense to use a Sully post as a starting point in your discussion, it is a bit unseemly to pretend at this point that the man is capable of rational conversation about, well, pretty much anything. I mean, this is a guy who appears obsessed with Sarah Palin's pregnancy. It's fine that he supports Obama, thinks McCain is a fink, and doesn't want Palin to be President. But he's passed the point of decency, and you probably ought to acknowledge that, lest you be tarred with the same brush given your affiliation.
I'd be fine with, say, Glenn Greenwald, but Sullivan is past the point of dementia.
"The challenges facing our financial system today are more evidence that too many folks in Washington and on Wall Street weren't minding the store. Eight years of policies that have shredded consumer protections, loosened oversight and regulation, and encouraged outsized bonuses to CEOs while ignoring middle-class Americans have brought us to the most serious financial crisis since the Great Depression."
""This is flat out untrue. And I know that Barack Obama is smart, and well-informed, enough to know it.""
His conclusion might be untrue. That the Bush administration did everything he says it did is not untrue.
That they saw this crisis coming and did nothing about it is also true. They were unfortunate where Clinton was fortunate, true, but that doesn't immunize them from criticism.
By the way, do the weak dollar and the inflationary spiral caused by high energy costs have anything to do with the current crisis? Of course they do, and both are tied in to very deliberate decisions made by this administration. Obama is quite correct to tie this situation around the necks of the Republicans and to push them off the goddamn pier. While they're drowning they can keep their eyes closed and hope for a miracle, which has been their policy under Dumbya for just about everything.
Just because the changes that one administration brings about (in contravention of party ideology) are needed at that time to stimulate growth doesn't mean that conditions during the following administration DON'T call for the rolling back of what was successful during the first adm inistration (which would also have been contra party dogma). Obama is saying clinton did the right thing under prevailing conditions and Bush did not. There is no contradiction in reality, only in Megan's doctrinaire mind.
"Regulate mortgage brokers at the federal level. Given the way mortgage funds now flow across state lines, this made sense. But the state governors would have screamed bloody murder. Moreover, no one knew about the fraud when it would have helped--i.e., before most of it happened."
That last sentence is meant as a joke, right?
I'm thinking the credit rating agencies now look like a total scam.
I heard someone say, "The Onion just reported that Standard and Poors downgraded Lehman... oh wait, it was the Wall Street Journal."
I believe that SPE accounting is coming to roost. A lot of this toxic waste was kept off of firms' balance sheets. Just cleaning up the accounting would have helped a lot. However, the current waterfall outstrips this explanation.
As to mark to market accounting. I don't really like it, but I can't come up with a good argument for treating trading securities differently. Allowing firms to reclass them as available-for-sale hold-to-maturity opens up nasty worm cans, too. There is no easy solution here.
I think there is a good argument for more regulation. The D/E ratios of the investment banks are obscene. Can you honestly tell me a firm with a ratio above 30 is not at serious risk of default? I'd still be nervous if it was at 15.
Err... why is it the Bush administration tried by failed to do anything about the GSEs?
Oh yeah, because the Democrats were largely in their pockets. In their pockets is maybe a bit of an understatement. Looking at Raines, Johnson, Gorelick, and the general contribution patterns of the GSEs, it might be fair to say that the Democratic Party and the GSEs were one and the same. It recalls, to more than a casual level, passages from Albert Scheitzer's Big Business in the Third Reich.
But more seriously, one thing I notice in studying politics is that real (and necessary) changes come when one side gets up the balls to say no to it's base. It took Nixon to go to China and Clinton to reform welfare. And so forth. When the Dems needed to, for everyone's good, tighten up control of the GSEs, they folded up.
"And asset price bubbles are really, really hard to pop. I refer you to John Kenneth Galbraith's description of the government's attempts to shut down the 1929 boom."
Hey! I'm reading that this week! And that's not at all waht Galraith said. Exactly the opposite, in fact:
"In the accepted history of these times, the Federal Reserve authorities are held to be not so much unaware or unwilling as impotent. They would have liked to stop the boom, but they lacked the means. This puts far too elaborate a face on matters. And it largely disguises the real nature of the dilemma the authorities faced."
p. 29
"In fact, the Federal Reserve was helpless only because it wanted to be."
p. 32
"Actually, not even new legislation, or the threat of it, was needed. in 1929, a robust denunciation of speculators and speculation by someone in high authority and a warning taht the market was too high would almost certainly have broken the spell."
Id.
Galbraith's argument is that it's very hard to get the political will to pop asset bubbles, not that they can't be popped by someone who wants to.
Megan shouldn't have to go to such lengths to explain this. Personally, I consider it very kind of her to go through all this trouble.
Once you get the gist the POV she's coming from, what she's saying not only makes but seems kind of obvious.
And it doesn't have much to do with having an advanced degree in economics as it does with having an appreciation that things can be over simplified in hindsight. I wish it was easier to explain because I don't think that quite gets the point across. But I think that to assess simple blame after the fact (especially when you would never know enough say otherwise before the fact)is satisfying for some but ultimately empty.
"Lowering CEO pay. Whaaaaaa? If Dick Fuld had been paid a dollar a year, we'd be in exactly the same mess. Probably worse, because what kind of CEO do you get for a dollar a year?"
Steve Jobs.
"How should the Federal Reserve have dealt with the river of money flowing into American markets from central banks and savers abroad? This was the primary culprit in the credit expansion, not the Fed--indeed, that's why the yield curve got so funny looking at the end."
Yield curve: You're funny looking.
Not fer nuthin, but might it have helped if we weren't borrowing close to a half trillion a year from said central banks?
Re: Mandate 20% down payments.
20% downnpayments were never mandatory, and in fact would prevent young people (unless from wealthy families) from getting into the housing market at all. In the past most low downpayment mortgages were FHA mortgages, backed by the government and with very stringent standards for borrower income, housing value etc., and also required carrying PMI to idemnify the lender in case of deafult. Returning to the standard would probably be enough to reduce risk to reasonable levels again.
I dunno, they could have made it more difficult to sell mortgages while the ink was still drying on them. Toward the end of the bubble mortages were failing almost as soon as they were issued, but not quite as quickly as they were sold, packaged and resold as bonds. I think the issuer should be required to hold the mortgage for at least a year. This would probably chase a lot of mortgage brokers out of business, but is that such a bad thing?
humm....
Here is a rule of thumb in knowing how / when regulation is needed, before it is too late.
The unmeasured / unmonitored risks are the ones that grow the fastest. (Exponential growth is another key sign that something "too good" is being done).
Ergo, if you just have the discipline to monitor the growth rates of various types of risks/instruments (or even the number of people selling/buying them, sometimes), you can probably get a signal for 100% of the risks that are sizable enough to eventually topple an institution.
The only other true indicator really wasn't present too much this time. Prior to the junk-bond / S&L meltdown, you could find tales of ... opulence and euphoria that were key indicators of "excess". That was masked this time around.
There appears to be evidence of serious violation(s) of concentration risks in the current crisis. Both Merrill and Bear clearly had too much "mortgage" in their portfolios... That sounds really basic and stupid, but the "big picture" often is.
Also, keep an eye on people who are 'getting high on their own supply', as one writer at Fortune or Forbes put it, when it was clear that their own trading desk as "attaching liquidity" in order for them to get a sale "done". This is the answer to the question of when is a risk-transfer not a risk-transfer, or, more basically, when is a sale not a sale. Those are two questions that every "brokerage" should know how to answer without hesitation, as part of the core business mantra. Merrill lost its way on that - see also evidence from their auction rate securities settlement ... !
Trevor, read the section on margin loan requirements. Also, note what happened when Ben Bernanke ran his mouth to Maria Bartiromo.
"I can demand that they be omniscient, but since I'm not willing to hold myself to that standard (nor, I expect, is Andrew), that hardly seems fair."
This statement gets at what I think is the big problem with Megan's assumptions. That this meltdown was just impossible to foresee, that trying to regulate was just not a reasonable thing to do.
Sorry, I just don't buy that. I've been reading articles for years that warned this was coming. My friends in real estate knew there was a serious problem 4 years ago. They just observed what was happening around them in real time.
I don't expect government to be omniscient. But, when a slow moving, 5 year trainwreck is taking place, I expect them to recognize the trainwreck near the beginning, not near the end. Would it have been so hard to see this coming in 2005? I don't think so.
Mark to market accounting -
It probably shouldn't be the sole, or even the primary valuation of assets (unless those assets are targeted/needed for sale over the short term). But it wouldn't hurt to have separate "our value" and "market value" columns on the balance sheet. Sometimes, perhaps often, the numbers would be redundant, but interesting opportunities would make themselves apparent if there were significant differences.
20% down, Force banks to keep some amount of the loans they originated. -
Let's combine these ideas and say banks can only resell mortgages with 20+% equity, but not prevent them from originating 0 down or whatever else they think would be profitable. This would reduce the principal-agent problem while still leaving financing options available.
Eric,
What about the unfolding trainwreck in social security and medicare? We can all see it coming, but nobody has the will to do anything about it.
I was impressed she was able to use the word "prophylactically" in a discussion about the economy.
Megan:
If you want to stop bank runs (which is what this is) the solution is very simple: eliminate maturity mismatch. If you want to borrow for 30 years, you need to find someone willing to lend for 30 years. Cash accounts are true cash accounts -- money sitting in a vault. Everything else is some flavor of a CD where you need to 1) wait until maturity or 2) find someone willing to take the instrument off your hands.
This will stop crises of liquidity dead. It will also control money supply, which is something the Fed should be doing, and which it does not (given that it turns a blind eye to credit).
It will not stop crises of solvency though, institutions will go bankrupt, they just will not have a ripple effect across the broader financial world.
I am disappointed that the US Government only bought 80% of AIG. It should have nationalized the whole thing.
-winterspeak
You mean "An increase in margins to, say, 75 per cent in January 1929, or even a serious proposal to do so, would have caused many small speculators and quite a few big ones to sell. The boom would have come to a sudden and perhaps spectacular end."?
I didn't mention that because there's no way we're taking margin requirements to 75% today, but that's still in the context of Galbraith arguing that the 1929 asset bubble would have been easy to pop.
The problem Galbraith points to is that bubbles are hard to deflate slowly, and bubble popping has the classic concentrated-costs-diffuse-benefits political economy problem. But it seems to me we don't really ever see these things deflate slowly on their own, so the benchmark for popping early isn't slow, measured drawdown later but a bigger, messier pop later. That weighs in favor of having either the Fed or a similarly insulated body have a permanent role as bubble hawks.
Tom,
Re: social security and medicare.
I'm not happy about those trainwrecks either. But I'm much more concerned about medicare (given ballooning medical costs) than I am about social security. And, I'm much more worried about off-the-books war debt than I am about either of those things.
Social security may be a trainwreck, but its a slower one (multiple decades) than a lot of other problems. By the time it collapses under its own weight my plan is to be fabulously wealthy.
I hope it works out for me...
Trevor - asset bubbles are easy to pop just like nuking your house is an easy way of getting rid of a roach infestation. They are both true but useless points. Destroying the village to save it never goes over well, no matter its effectiveness.
The only prospective way to eliminate a bubble is to deflate it slowly. The necessary level of action very tricky to get right thanks to the substantial pressures causing the inflation and the disastrous consequences of too much destructive force.
People's half-assed attempts to eliminate risk would be ridiculously contractionary. There just aren't enough individuals and institutions who need or want to lend long. Banks are set up for the EXPRESS purpose of setting up maturity mismatches. If you can only extend a mortgage if you have someone willing to give you 30 year money, you will completely destroy the housing market. I'd really prefer not to live in an agrarian autarky or 8th century Europe that had no financial institutions.
I'm really shocked that winterspeak wants to go back to dark age Europe.
"And I know that Barack Obama is smart, and well-informed, enough to know it."
All right, how do you know that? Let us grant that he was was smart enough to graduate from Harvard Law, with honors. But why do you think he is well-informed, especially about about economic matters?
He has never studied economics, he isn't much of a reader, and he isn't intellectually curious. He holds some positions -- for example, his opposition to the free trade agreement with Columbia -- that almost all economists would oppose. And he hasn't been in national office long enough to learn much from hearings and briefings. (Even assuming he was spending much time in such boring pursuits.)
Isn't it more likely that he is not "well-informed", at least about economics? So he may believe what he says. Or, more cynically, he may not know or care whether what he says is false.
(Some evidence for my claims that he is not well read, and not intellectually curious: Amazon has an interview with Obama, accompanying one of his books -- I forget which one. They ask him what books he has read. His answer is embarrassing. And, no, there were no books on economics in his pitiful list.)
"Lowering CEO pay. Whaaaaaa? If Dick Fuld had been paid a dollar a year, we'd be in exactly the same mess. Probably worse, because what kind of CEO do you get for a dollar a year?"
Uh, worse how? Shares at 15 cents instead of 30?
/end snark.
On a serious note, your former co-blogger is obviously right. Our whole financial system is a house of cards since all the borrowers are borrowing long and the lenders loan short. Works great until the lenders get spooked; then there's simply not enough to pay them off. That's round 1; round 2 is when all the lenders try to get out because if you're early you might get paid and if you're late you definitely won't.
Maybe that crazy ranting by Ron Paul about the gold standard had something to it.
Eric hits the nail on the head.
Anyone watching the markets could have foreseen this if not in 2005, at least in 2007 when the housing bubble burst. And even if they didn't see it then, it was obvious even to the uneducated public (such as myself) when Bear Stearns collapsed.
And still nothing was done to forestall the furthering crisis. Why? Because the current Bush administration is hamstrung with blinkering incompetence, and can't even get food and water to FEMA workers, let alone regulate the shadow banking system and financial markets.
And we're being told this isn't the end of it. So we'll fumble from crisis to crisis until Republicans are out of the White House.
My favorite arguments are the ones that insist that, if only that dummy Bush hadn't been President, then the good guys would have done...something fabulous!
Stories like this should always end with "...and they lived happily everafter."
"Anyone watching the markets could have foreseen this if not in 2005, at least in 2007 when the housing bubble burst. And even if they didn't see it then, it was obvious even to the uneducated public (such as myself) when Bear Stearns collapsed."
I assume then that you're a billionaire from all the puts you've been buying up since 2005.
Since the Fed will soon own most of the US economy, I guess we should expect them to manage it more effectively :-) Or, or we doing the equivalent of turning over the economy to FEMA?
Could we have seen this mess coming? My 89 year old mother, who lived through the Great Depression, watched the nonsense unfold and sold her California home of 50 years in 2005 saying "There's going to be a crash". While she is very smart, she has no formal training in finance, real estate, economics or any of the other topics so studied by our investment gurus who have run their firms into the ground.
I have a couple of questions:
1. What role did Greenspan's easy money policies have on creating this bubble?
2. How could these giant financial institutions buy so much paper and not understand what was backing it up? And why isn't their buying this paper just like me buying the latest miracle cure from an info-mercial?
3. If, for argument sake, Libya paved its desert with solar panels and offered the United States 100% of the power we required, then should the United States accept this deal? Of course not, because we would then be at the mercy of Libya which would not be good. Why then have we left these financial institutions grow so large that their failure threatens the world's entire financial structure?
That's a long list of things we could do, Megan! Not necessary. Let me make a suggestion.
“Put to the vote: as many are of the opinion that a public tax upon the land ought to be raised to defray the public charge say ‘Yea!’….” “Yea!” “Carried in the affirmative, none dissenting.”
That was Philadelphia’s first tax law, on 30 January 1693.
They knew that land rent is a community surplus, and that you shouldn't tax people for working, or on the goods they buy! But we're very clever and sophisticated now: we know better. So we tax people, drive producers offshore and our tax regimes turn the country to speculative pursuits - where the tax breaks are!
Here in Oz, we assess a land value on every property, but as with the USA, as each property bubble bursts, we listen to the property lobby and reduce property taxes because they scream loudest - as with California's Proposition 13 in 1978 - instead of doing precisely the opposite.
We don't need a whole lot of regulation. Our revenue systems have got to encourage doers and penalise speculators. Pliny the Elder said that wealthy landowners destroyed Ancient Rome. It's also bringing about the slow but inevitable death of Pax Americana.
What about CDSes? Was it really necessary to let just anyone write these things out of thin air without any kind of limitation or transparency? Even if CDSes didn't cause the crises, they most certainly amplified the problem.
It seems like the government is taking out a loan itself through deficit spending, in order to buy . . . Debt? This doesn't sound like a good long term strategy. Is the US government, by trying to keep these institutions in business going to end up nationalizing the financial industry? To think, this is all the result of people flipping or dreaming about flipping their goddamn houses.
Breaking: Crook endorses Obama rhetoric on crisis:
"The Obama campaign is leaning heavily, and with much justification, on blaming the Bush administration for what has happened."
Pardon me if I tend toward relying on Clive's judgment over Megan's.
Jim Miller: "[Obama] has never studied economics, he isn't much of a reader, and he isn't intellectually curious... And he hasn't been in national office long enough to learn much from hearings and briefings... Amazon has an interview with Obama, accompanying one of his books -- I forget which one. They ask him what books he has read. His answer is embarrassing."
none of this is true, just FYI.
This absolutely represents a failure of prospective regulation. You say so in your post -- you offer eleven fleshed-out steps that could have been taken and weren't. You are of the belief that it is illegitimate for the party out of power to call attention to those possibilities as things the party in power failed to do. This is because you have decided it was just too politically difficult to expect the party in power to do them. Not that they require too great a systemic understanding of ongping events amounting to an expectation of perfect foresight. You could make that argument, and someone might buy it, but you don't. You just think the possibilities you suggest were too hard to expect leaders to pursue. So the party out of power (and hence the voters) should just let them off the hook. That is the form of your argument.
It would have been hard to resist the temptation to use 9/11 politically too. And apparently it was hard to bring peace and democracy to Iraq after electing to overthrow its government on 'faulty intelligence.' Is there anything else we need to let this party off the hook for because it would have been hard to do otherwise?
The key point here is that voters don't have to prepare legally persuasive cases in their minds before deciding to throw the bums out. They can just decide they don't like bums. And politicians can make it that simple for them. The best ones do.
Barack Obama does not have to contort himself to take the party of George W. Bush off the hook for the various faiscoes that have befallen the country on their watch. He is fully within his rights as a national leader to paint a simple picture and let us decide if it matches our take. If it were up to me, he'd be even less fact-oriented and fairminded toward the oppositionthan he is being. All he should have to say is "Just look at this shit, will you?"
He is being more than fair to the party that has overseen this catastrophe and a few others.
"This is flat out untrue. And I know that Barack Obama is smart, and well-informed, enough to know it."
If he knows it is not true and says it anyway, is that not just cynical politics as usual? Where is Change? Where is Hope?
I actually think he is no where near as intelligent as people think he is.
"Banks are set up for the EXPRESS purpose of setting up maturity mismatches."
========
"Hey", this appears to be another meme that is loudly being propagated about the 'investment bank' model.
It's not true.
You can run a perfectly matched ALM book and still make money.
The tension comes because you can often, but not always, make more money, if you mismatch.
Of course, if you are punch-drunk, like Countrywide (?), and you don't have a professional liquidity manager in your #1 or #2 slot, you end up with something patently ridiculous, like 80% of your "long-term" liabilities financed with 30-day money.
There are choice words for that, and they cannot be printed. Such people should probably be taken out and have their tans sand-blasted off them, because their recklessness has caused a lot of pain to their dutiful employees ....
Re: I think the issuer should be required to hold the mortgage for at least a year.
Originators were required to buy back mortgages that went bad within six months (generally) of sale. This is why mortgage companies like New Century went bankrupt.
Keep in mind banks from other countries were buying CDOs too. Are German regulators taking orders from the GOP too?
I do think that states like CA should have banned no doc/lo doc.
I also wonder what is an "off balance sheet entity" and why should those exist...don't balance sheets exist for a reason?
However, even with the best regulations, stupidity and greed still exist.
p.s. I am curious about the Chinese lead in toys...did we actually randomly test toys in stores at some point in the past?
"Keep Fannie Mae and Freddie Mac out of risky mortgages, and give OFHEO some teeth. Bush and several Republicans tried, and failed, to do this."
Here's another flat-out-untruism, at least if Mike Oxley's recent comments in the FT are to be believed. He blamed the Bush White House for the failure of reform legislation addressing exactly those two points. He and Barney Frank got a bill thru the House in 2005 (330-90 IIRC) but it died for lack of sponsorship in the Senate after the WH said fergeddit. Paulson came on board then but couldn't get a compromise between the Bush WH desire to kill Frannie, and the Congress's desire to regulate it.
Cheerful Iconoclast speaks for me. Great post except for the opening phrase.
Set up the accounting rules, Basel2, whatever, so that if you keep OTC derivatives contracts that you have to recognize that counter-party risk at a much greater level than if they were exchange-traded.
People can make whatever contracts they want with each-other. But, the counter-party risk needs to be recognized.
I don't look in here very often any more. A while back I suggested this blog could either go the way of Angry Bear, Calculated Risk, etc, giving reasoned opinion on cited facts and figures. Or it could go the way of backwater blogs like Cafe Hayek: wide-eyed malicious ignorance, opportunistic contrarianism, the spectacle of the pump-house gang circling the wagons in rampant displays of tribalism. Guess which way the cookie crumbled?
Sigh. As an example:
Right, the wide-eyed, "Who could have known?", the artifice of cynicism: "Does anyone seriously the party in power could have engaged in those battles, given the costs they would have incurred?" This from the woman who wonders about why people who were right about Iraq along are bitter at still being shut out of the decision-making process.
In point of fact, responsible officials _have_ made decisions which cost them and theirs dearly. How about the Omnibus Reconciliation Act of 1993? The one that everyone knew would be politically costly? Clinton and the Democratic congress did what they thought was the right thing and voted for tax increases. This cost them control of the House (and arguably, directly lead to the present fiasco), but they went ahead and did the responsible thing.
Or how about Johnson and his Civil Rights program? The program that he knew would cost his party for a generation? Yet, rather than do the expedient thing, which Megan suggests was the only realistic path of action, he did the responsible, right thing, the 'politically unfeasible' thing.
Note that in both cases, the 'Party of Responsibility' took full advantage the Democrats being good guys, and ruthlessly exploited their advantage.
So, yes, it is possible to do the right thing, even though it costs dearly. The Republicans haven't done it, and haven't done such a thing in a long, long time.
Anyone of course, is free to come up with specific ,cited examples to prove me wrong. But on this blog, in this environment of irresponsibility, I'm not holding my breath.
Megan,
Can you elaborate on this statement, perhaps with dates, examples and/or links?
Keep Fannie Mae and Freddie Mac out of risky mortgages, and give OFHEO some teeth. Bush and several Republicans tried, and failed, to do this.
Many thanks!
I'm glad to hear someone call a politician on their inane financial babblings. McCain said he didn't understand the economy well enough, and he was right. The dirty little secret is that Obama doesn't, either, nor do most Presidential candidates. If they did, they'd never say things like the above.
Given that it's so obviously false, I greatly look forward to Andrew calling Obama a lying liar who lies. Shouldn't hold my breath, though, right?
Megan Said: "But if you are looking to place regulatory blame, whatever changes you'd care to point to happened on Clinton's watch, not Bush's. You cannot have it both ways--hailing the Clinton genius at economic management (and implying that Obama will bring back those halcyon days), and then claiming that Bush should have trailed around undoing all his work."
Why not? Bush undid effective tax policy, Constitutional law in way too many ways to count, the Geneva Conventions, environmental laws, and world respect, to name a few. The list of things the current administration changed for the worse is endless. Couldn't we expect him to get "something" right if he really, actually wanted to?
"This is flat out untrue. And I know that Barack Obama is smart, and well-informed, enough to know it."
When it comes to economics, McCain is the better informed. Barack has yet to admit he doesn't know a thing about it.
Not to sound too much like one of those astroturfing trolls, I am a pretty serious conservative, not quite Ron Paul nuts, but pretty close. I think this article was FANTASTIC. I still think you missed the fullness of the cultural issue. We have a sitting representative who has walked out on a loan to buy a better place at a lower price, and many others saying "why not". If there are no consequences individually for cheating the system, most will cheat the system. We had the Bush administration actively trying to help low income people purchase homes. Because of all the studies showing that owners care more for their properties than non-owners, it seemed like a good way to clean up low income areas. Instead, it appears that sometimes non-owners are non-owners because they are incapable of the responsibility of ownership, and rather than demonize this, once again government would do well to keep it's wretched hands out of the affair altogether. I'll never forget when a woman at work told me she had bought a house at the same time I did, even though she was a single parent living on welfare (at 40, there are no timelines here in Oregon). Despite the fact that her interest rate was a full 2% lower than ours was, she confided she didn't make enough to make the payments. I thought to myself, who the heck would lend this woman money? Oh, that's right, me!
Just got directed here by Jonathan Miller who suggested I read this while listening to Charlie Rose. So here I am and I simply must comment.
Somebody ahead of me observed that politicians running for office don't understand economics. Well, who does?
There once was a guy named Keynes into whose doctrine I was brainwashed. It seems he thought up a consumer confidence index which looks all the rosier when consumers spend everything they have and then some.
Apparently the reverse of spending is called saving and that doesn't look so good in the reports.
Guys, I don't think its the politicians. Its the economists who don't understand what it takes to sustain.
My Grandma's economics makes more sense than ever. "In all things show moderation" and "Save for a rainy day."
If I understand the investment bank debacle it is that they were highly leveraged which means bankrupt to us commoners.
It is past time to make the switch nationally from Keynes to Grandma.
Oh, then there is the perceived need for transparency. Which is sort of like needing people involved in the financial system to tell the truth and be responsible. I guess AIG is a victim of the spin doctors now. Victim my foot! AIG had to be making a pretty buck or two off this Hollywood version of finance.
The whole thing may not been a house of cards, but some of the underpinnings were pure spin and the story changed.
Heya Megan,
C'mon; getting a little too harsh on Obama, aren't you? I'm no expert about this myself, but there are at least two aspects of BO's regularoty proposal that seem to me might actually have helped a little in this case. (Notice, I don't say 'prevented the crisis'; just 'might have made it less catastrophic'!)
1. To quote, ummm, Megan...
"I should note another thing regulators could have done, which is required more reserves."
And this is a key part of the Obama proposal for "increased regulation," isn't it?
And 2. Increased mortgage term transparency. of course part of the problem was that people willed themselves into believing that they could afford mortgages they couldn't afford. But it is a lot easier for that to get traction when the terms of the contract you are signing are obfuscatory, and the "expert" sitting across from you, who claims to understand what they "really" amount to explains them in reassuring tones *meant* to engage your motivated believing. Greater transparency would have activated a bit more risk-averse instincts in consumers as the whole thing unfolded, and surely such transparency could be made a part of Federal truth-in-lending, no?
(I say this, again, not as a financial expert, but as someone who *has* had the experience of actually reading the fine print of some mortgages-- Sheesh!-- and someone who has thought seriously about the problem of motivated believing in moral psychology.)
So, shouldn't you climb down from the high horse of Street experience just a little bit on the Obama response here?
Inquiring minds will want to know.
Lanier
The "No one could have foreseen it" defense! As always, the last refuge of fools.
Here's some dame named Jane Galt back in March, 2005: "Is the American economy experiencing a housing bubble? Damn straight."
It can't possibly be said, and certainly can't be said by Megan, that no one could have seen this coming. The truth is that everyone with even a passing acquaintance with economics knew that housing prices were going to start coming back down to earth. And anyone who was paying attention knew that a lot of people where getting in over their heads with risky, exotic mortgages premised on the notion that housing values would keep rising and interest rates would stay low.
What most people didn't foresee is just how widespread the damage would be when the housing bubble collapsed. Why didn't we foresee this? Because we don't work in the financial sector and had only a vague notion of the various shell games being used to pass around housing debts and disguise their value. The question is why highly-paid financial experts, high-profile "econobloggers" and federal regulators were caught off guard by these developments. And I'm convinced the answer is that they didn't know much more about collateralized debt obligations and "innovative securitizations" than the rest of us. Billions of dollars of bad debts were being sold in obscure and minimally regulated markets, and few cared to know how or why.
I have not seen a compelling rebuttal to Kuttner's account of where financial deregulation went wrong. The entire raft of reforms over the past 40 years were geared toward encouraging innovation and complexity in the market for the sake of stimulating growth, and it created growth. But the complexity ballooned to such an extent that it institutionalized practices that nobody fully understood and did not serve the public interest... much like a bureaucracy that's grown too unwieldy for anyone to control.
The Progressive Era and New Deal regulations, which Megan loves to dismiss with a sneer and an offhand Hayek reference, were premised on the notions that no business should be allowed to grow large enough to distort the market and become too big to fail, conflicts of interest should be banned, investing on the margin should be banned, and investments should be simple and transparent. They foresaw this sort of problem 75 years ago. Their worldview has been discarded because it was seen to be a drag on growth. Allow me to suggest that these discarded regulations were only a drag on phony growth-- the sort of economic growth that takes the form of fleeting, bubbly frenzies that end up sticking a bunch of suckers with the bill.
I can remember seeing the all knowing commenters onf Loius Rukeyser's "Wall Street Week" talk about having actually never bought or sold a "call" or a "put".
Now we have "naked put selling", which when it was described to me sounded like plain old fraud.
No wonder there are problems.
I just hope that this doesn't all get swept under the rug, the way the Fannie Mae bookkeeping scandal did. I hope somebody, who deserves it, goes to jail.
There were two big underlying causes of the problems today. One is that the Fed kept interest rates too low for too long after the tech stock bubble burst, fueling excessive housing demand. The other is that local governments hindered the supply response when housing prices started going up. This in turn fueled an even greater speculative demand for housing. Everyone wanted to own a house or two, even if they couldn't afford it. It was the way to get rich!
In places where zoning did not prevent it, rising home prices led to building booms that prevented prices from accelerating further. There was no bubble in Houston. Had this been the case nationwide, it's quite likely that Wall Street models that assumed ever-rising housing prices would have been differently specified. As it was, for several years there you could get away with lending money to anyone with a pulse, secure in the knowledge that a borrower in trouble could always sell the house to repay the loan. Lenders probably would have paid more attention to the creditworthiness of the borrowers if they hadn't been lulled into thinking that house prices always go up, and by a lot.
I realized today that repealing Glass-Steagall's commercial/investment bank prohibition actually has allowed for the some of the solutions here:
BofA buying Merrill
Wachovia buying Morgan Stanley
Lloyds buying HBOS
not possible in a Glass-Steagall world.
Bill Clinton solved the credit crisis.
We'll see, of course, how it all plays out...
The time for sacrifice is now.
No more buying the dream on time.
The creditors have us in their back pockets and it is our fault.
This great country and the citizens who are lucky to be in the land of freedom need to reinvent the wheel.
Federal spending needs to decline dramatically and we need to pay off our debts.
Bankruptcy is failure. We are better than this.
The Clintons and their congress (it was) made the banks give risky loans to people who had no business buying a house (at the time). This is an upwardly mobile country and those that shouldn't have been given loans were given loans before they were ready. The Clintons (and their congress) did it for political points (what else). The rich elites in your congress continue to risk your kids livelihoods to fulfill their fantasies too. So I now hereby present the only solution: Term Limits. Before it's too late!
What a crock this post is. The regulation ideas are surface-level and clearly skimmed from the comments sections and newspaper business sections -- look elsewhere for expertise (does Megan ever, ever spend any time interviewing actual experts or reading the academic and technical lit? Hint: Tyler Cowen is not an expert in this stuff). But the typically mendacious part is this Panglossian bullshit -- all must be for the best in this best of all possible markets. Were any alternatives feasible, could anything have been improved? Hey, "I don't see it".
Tons of people have been warning about the dangers of derivatives for years and the need to more closely monitor and regulate them, led by such well-known socialists as Warren Buffet. The entire system of structured finance monitoring was fully privatized and handled by basically unregulated ratings agencies that had hopeless conflicts of interest due to financial ties to the securities issuers. You might think it would be pretty easy to do better than that, but sorry, Hayek proved that it would be impossible back in the 1940s and Megan is here to regretfully explain it to you.
The argument that better regulation was *politically difficult* is especially annoying. First, it's obvious -- it didn't happen, so it must not have been easy. We don't need an "econblogger" to tell us this. Second, a big reason it was politically difficult is the thoughtless libertarian-lite ideology Megan and others have been pushing for decades. (It's not a coincidence that for 50 years after it was put in place our financial regulation system was stodgy but worked pretty well to create stability, and then starting in the mid-late 80s we get a go-go era marked by big financial blowups every decade or so.). The fact that most of our political and economic establishment was in the tank for Wall Street and thoughtlessly dismissive of regulation is not a reason to be thoughtlessly dismissive of regulation.
This is sort of a repeat of the Iraq stuff. Your ideas don't work? Not a reason to reconsider your ideas! Instead, let's just reflect again on how much more thoughtful our perspective is than that of our critics.
Andrew.....is that Andrew as in Andrew Sullivan?
Why bother, isn't he generally considered insane at this point?
in re: to eric -
"Sorry, I just don't buy that. I've been reading articles for years that warned this was coming. My friends in real estate knew there was a serious problem 4 years ago. They just observed what was happening around them in real time."
Try nine years ago on the house floor with John Dingell, in regards to the Gramm-Leach-Bliley Act:
"I just want to remind my colleagues about what happened the last time the Committee on Banking brought a bill on the floor which deregulated the savings and loans. It wound up imposing upon the taxpayers of this Nation about a $500 billion liability. That is what it cost to clean up that mess.
Now, at the same time, the banks by engaging in questionable practices wound up in a situation where the Fed and the Treasury Department had to bail them out also at the taxpayers’ expense. But it did not show."
Interesting that though this act had "nothing" to do with the current financial crisis, it's effects as predicted by Rep. Dingell are oddly prophetic.
And there's this thing about credit default swaps, a practice enabled by the act i'm assuming. But I'm not really all that sure. Anybody out there who can expalin it to me?
As far as exonerating Gramm-Leach-Bliley is concerned, I'm a little confused. Didn't it also free up investment banks as well as commercial banks, thus leading them to get themselves into huge trouble, as mentioned here:
http://www.nytimes.com/2008/10/03/business/03sec.html?_r=1&adxnnl=1&oref=slogin&adxnnlx=1223154191-HS7gqDX8HWvwjv/r/qXKcg
I'm just curious.
A link to a New York Times article to support a point? How pathetic. The Times is a sewer of bias at every level.
Paul Revere, please forgive my ignorance. I wasn't trying to "prove" a point. I was asking a question about the issue, a question that I came up with while reading that article, a question that I was hoping the bright minds on this blog would be able to answer.
The Times article doesn't mention anything about my question. Hence, I mentioned it here because of the relevance to GLB. Your claim of bias for "refuting" the "point" is what we in philosophy would call "poisoning the wells." That you would claim I was making a point, or even using the article to support it, further demonstrates your deficiency in thinking and reasoning. If you would like to provide a reason why that specific article is devoid of fact, please feel free to do so. Are you saying that the SEC did NOT facilitate the investment banks in getting in over their heads, especially with the lack of promised oversight? Please advise.
As for my question, I'd really appreciate a response from someone more intelligent things to offer than Paul Revere.