- Recency effect: People tend to overweight recent events in considering the probability of future events. In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high. Now I rate it as much lower. Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it's much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan. My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.
- Bandwagon effect: People tend to believe that something is a better idea if a lot of other people are doing it. In essence, they are trying to free ride on other people's analysis, on the assumption that someone must have thought this thing out. This has its uses--we don't all need to learn every hard lesson for itself. But in markets it produces herding behavior, which makes outcomes more extreme on both the upside and the downside. In other words, we get booms and busts. In the professional world, this is exacerbated by the fact that you're less likely to get fired if you fail at the same time everyone else does.
- Availability heuristic: People tend to overweight data that comes easily to mind, which is to say vivid (extreme) and recent examples.
- Beneffectance: People tend to view success as a result of their own actions, while they view failures as having been due to factors largely outside of their control.
- Confirmation bias: The tendency to look for data that confirms your theory, rather than data that falsifies it. Yes, we all know how this works in politics, but it's a much broader problem. People will repeatedly devise tests that give positive proofs of their theories, but much less often devise tests to falsify them.
- Hyperbolic discounting: People value small short-term payoffs more than much higher long-term payoffs.
- Optimistic bias: People tend to be overconfident about their own abilities and the outcome of their plans. Something like 90% of people think that they are above average drivers less likely to get into an accident than the average joe. This is so pervasive that there is actually a scientific name for the few people who accurately assess their own future, their abilities, and what other people think of them: clinically depressed.
- Overconfidence bias: Relatedly, people are too confident in the accuracy of their predictions. When asked to estimate a range of possibilities where the true outcome is 95% likely to fall within that range, people's guesses are wrong 40% of the time.
Homebuyers looked at 50 years of basically steadily rising home prices, with few and small declines, and concluded that rising home prices were some kind of natural law. In fact, the run-up in home prices was the idiosyncratic result of a lot of factors: the move to long-term self-amortizing mortgages; the home mortgage interest tax deduction, which became steadily more valuable as income tax rates rose; the steady decline in nominal interest rates, which lowered monthly house payments for any given home price; severe regulatory contraction of supply in a few areas.
As capital flooded into the US debt markets in the wake of the Asian financial crisis--and I think that Asian savers and central banks bear much more of the responsibility for the credit bubble than can be plausibly pinned on either Alan Greenspan or Ben Bernanke--real interest rates also fell, which made housing an even better deal. The recency effect kicked in: as the bubble grew, it began to seem more, not less, likely that home prices would continue to rise. The bandwagon effect also reared its ugly head. Everyone else was buying a house on potentially catastrophic terms, so it must be safe!
Any self-introspection on the safety of the housing market was also plagued by bias. Examples of falling house prices were not available to memory; spectacular coups reaped by coworkers on a two bedroom fixer-upper were. And in testing their theory of future house prices, people looked for reasons that housing prices might rise--the many amenities of homeownership wherever they happened to live--rather than thinking of reasons that it might fall. Besides, the memory of the stock market crash was extremely recent and vivid. People began to see a home less as a place to live than an investment, a safe alternative to the risky securities market.
Once they had decided that it was likely to rise, they were overconfident in this assessment, which made them rather careless about the terms under which they signed mortgages.
Lenders went through much the same pattern. The revolution in credit scoring that took place in the 1990s actually did make lenders better at predicting default risk. As we moved into the current decade, however, the steady rise of home prices started to skew the numbers. Borrowers who historically might have defaulted simply sold their house into a rising market, recouping at least the value of their mortgage. Or they refinanced, getting much better terms because the loan now represented a smaller proportion of the overall value of the house, meaning that lenders were more likely to get all their money back.
As default rates fell, lenders went through the same process borrowers had. They too, overweighted recent events. They, too, looked at other people lending and concluded that it was probably safe. As I think I've mentioned before, several years ago, I had a conversation with an investment banker who did a lot of debt deals. As a general thought, he stated that we'd gotten much better at managing credit risk in the last ten years.
"Have we actually gotten better?" I asked. "Or do we just think we've gotten better."
"Oh no, we've really gotten better," he assured me. Oops.
Lenders built their risk models around pre-payment risk--the risk that buyers would refinance their mortgages, making your investment suddenly much less profitable. That had historically been the main risk of mortgage lending. As defaults stayed low, year after year, they revised down their expectations of default, viewing the current situation as a "new normal" rather than an unusually rosy time that might eventually regress to the mean. They tended to be overconfident about the probability that they were right and the boom would continue, making little provision for an eventual rise in defaults, much less what Nassim Taleb calls a "black swan" event, the kind of broad crisis that we see today. And they attributed the profits thus made to their own brilliance, rather than luck.
Lenders did have another set of pressures working on them. For any individual lender, it was better to all fail together than to underperform separately, and not merely because a massive failure might bring on a bailout. Any individual loan officer or risk manager would be much less likely to be blamed for incompetence if everyone else in the industry was having the same problem. Moreover, the drive for the year-end bonus led people to hyperbolic discounting--to get it while the getting was good, and worry about the future later. And, of course, if they did underperform, they would soon have no money to lend, because the investors would take it elsewhere.
So, too, the lenders confirmation bias and availability heuristics led them to construct stories about why the new situation was normal, and would not regress to the mean. Credit scoring had gotten better, house prices had never suffered a broad and sustained decline since the Great Depression, and of course, our old favorite "Real estate is the only thing they're not making any more of".
Investors--the people who bought the mortgage backed securities--participated in much the same madness. Just as lenders had seen declining default rates as evidence that they could safely make riskier loans, investors looked at the recent performance of mortgage-backed securities as something of a natural law. Hedge funds and investment houses ran more of their tests against historical data than against a broad range of individually unlikely scenarios. Most importantly, they drastically underweighted systemic risk. That is, they looked hard at the likelihood that an individual security would underperform. But they didn't look at what might happen if house prices suddenly dropped ten percent, or credit markets violently contracted. They chased high returns while underweighting risk, which put pressure on lenders to do the same--if they didn't, the investors wouldn't give them any money to lend.
Just like the lenders, investors saw their excellent performance in a boom market as evidence of their investing acumen, their ability to pick good securities or good sectors, rather than evidence that they had gotten lucky in a time of easy money. And because many investors, like hedge funds, pension plans, and mutual funds, have their own investors chasing returns, they were subject to the same pressures to take on more more risk that the lenders were under. In particular, they started taking on a lot more leverage, borrowing money in order to lend it. This is the practice that brought down Long Term Capital Management.
Perhaps the most important point is that regulators, the bonny chaps who are supposed to save us from all this madness, displayed the same pattern. So did the politicians behind them. Over the past few weeks, much has been made of the various regulatory actions that enabled this mess. Though some are wrong, two are not: the Democrats protected OFHEO's shockingly loose regulation of Fannie and Freddie against the White House's attempt to toughen it; and the Republican-appointed SEC loosened the capital requirements for the five largest banks.
But why did they do this? Democrats seem to believe that the Republicans and the SEC simply did this out of wanton greed and a blind faith in markets; Republicans seem to believe that OFHEO, the Democrats, and Fannie/Freddie did this because of political corruption and a blind belief in homeownership for poor people. But neither side was simply accepting the risk that the whole thing might come crashing down leaving the economy in tatters and the taxpayers on the hook. The regulators, too, were misled by recent history. In recent history, lending had been safer, and risk models did seem to be performing better. Both groups genuinely believed that improvements in both computer models, and in economic theory of regulation, would allow them to identify and halt any crisis before it occurred. And just like everyone else, when no disaster occurred, they became ever more confident in their own genius.
What we need, fundamentally, is not simply stricter regulation or less greedy bankers. What we need is better economic theory of how these things play out, so that the regulators have better tools to assess and prevent systemic risk. But that's not how we're thinking right now. What we're looking for is not better tools, but someone to blame.
Because, after all, we know that it wasn't us who was at fault. We're just the victim of broad market forces outside our control.
A thousand thanks for explaining blameless crime and punishment-free theft. The whopping Wall Street bonuses were all honestly earned, because who could possibly have forsee the problem? The facts that Warren Buffet called exotic derivatives "financial weapons of mass destruction" and state regulators were trying urgently to get reckless mortgage lending under control were just random noise in the system. Uh, huh.
McArdle simply cannot associate greed with wickedness. Like an Ayn Rand replica talking doll, she keeps chirping away about how swell everything is when government stays out of the way.
This disaster happened because the heroic chieftains of capitalism took over and neutralized the government agencies charged with controlling their "animal spirits." Greed is not just bad, it is wicked when it wrecks an entire economy.
Get used to it, Ms. McArdle. Your ideology is wicked.
The madness hit on both ends. On the buyer end, when some jackass takes out interest only teaser ARM, it allows him to borrow much more money than he otherwise would have. He can now outbid honest people with the same income who are taking out a standard 30 year mortgages they can actually afford. This artificially drives up housing prices and reinforces the irresponsible behavior. For a long time the jackasses who took the arm, got off well by flipping the house before the interest came due. The fact that it works for a while encourages other people to do the same thing. At that point, it is nothing but a ponzi scheme of speculators selling to other speculators with a price based on nothing more than the anticipation of further gains.
The same thing happened in the investment banking world. I am quite sure that there were some fund managers who made the point that housing prices could not go up forever and these securities were insane. Those people were no doubt told to shut up and look at Lehman and AIG who were making billions rather than the usual 10%. In the same way the honest borrower could not compete with the reckless one in the home market, the prudent fund or bank manager could not compete with the imprudent one when the bubble was going up. The end result is that everyone ends up paying too much for their homes and bankers and fund managers ended up getting into MBS's because they couldn't afford not to.
I would also blame a lot of this on the home mortgage deduction. It is the only tax deduction available to most people. As a result, most people's wealth is tied up in their home. Since you can't save and invest in normal amounts without getting killed on your taxes, most people's wealth is in their home. This creates the idea that homes, unlike every other good or commodity in the economy, must always appreciate in value. Imagine if we did this for everything else? My computer I bought three years ago is now worthless. My car is worth much less now than when I bought it even though it runs perfectly and looks great. In those contexts this is a great thing. It means the quality and price of computers and cars are going up. The fact that my thoroughly useful and attractive car wouldn't fetch a good price in the used car market means that lots of people can afford cars.
Homes are a little different because they are such a long term investment. The goal ought to be price stability. The goal ought to be stable affordable home prices. Price stability is always a good thing. It allows people to make intelligent decisions and keeps new entrants from being priced out of the market. Since everyone's wealth is so tied up with the value of their home, we got away from that. Homes must rise in value because if they don't people's wealth doesn't rise. That is insane. Home cannot rise in value forever nor would we want them to. We need to have a system where people save and invest and the rise in wealth comes from real gains in wealth and not just paper gains in home values
and the Republican-appointed SEC loosened the capital requirements for the five largest banks
Actually, both the Republican and Democrat appointments on the SEC voted in favor of revising the net capital rule. Can't pin that one on just Republicans.
I'm a victim of soicumstances!
Megan,
You make some good points and overall it's a solid piece, but I have an issue with the opening line: "Another way to think about it is as a series of cognitive errors that afflicted everyone"
My only issue is that it didn't affect "everyone." It affected people with a certain ideology. You know the one I refer to.
This is a natural consequence of the Feds, via the FMs, to "improve" the banking system. This sort of thing will only stop when that lesson is learned.
On the SEC: The SEC's commission is bipartisan, and though the SEC had a Republican commissioner, the change in capital requirements was unanimously approved. The capital requirement was and is intended to protect investors, not to protect the financial market from systemic risk. And the reference to "banks" should be to "investment banks"--we're talking about ML, Bear, Goldman, Lehman, MS.
Also I guess I should add, in reference to "looking for someone to blame".
In engineering, we call this "root cause analysis." As uncomfortable as it may be, sometimes we have to identify the problem so that we can correct it.
This process is only painful if you have a personal investment in a certain outcome. Sadly, there are few people who can detach themselves like this.
The quote "a foolish consistency is the hobgoblin of small minds" may be tired and cliche, but it speaks to an eternal tendency we all seem to have.
Super, super post. I've been really annoyed by the way everyone insists on treating this crisis as some kind of morality play with whatever cardboard cutout villains they prefer. Doubtless there were a lot of obvious bad guys, fraudulent lenders, flippers with no hope of landing a decent mortgage, bank executives chasing bonus and stock price with blatant disregard for risk, but, as Tyler would tell you, we need to focus on the marginal cases. The obvious bad guys are easy to deal with, but they are a minority. The tough issue is going to be handling the well-intentioned people who succumb to their biases.
As a corollary, the one thing I would change about your post is I would focus more on regulatory failure. The whole reason we have regulation is so that a systemic disaster doesn't result whenever bankers screw up. Think about it this way: Your list of biases that contributed to this mess looks a lot like a list of characteristics of a successful entrepreneur. Without using hindsight, do you think you would have been able to distinguish between the real revolution of credit scoring and the phony revolution of subprime? I doubt that I could, and I know that regulators couldn't. I suspect that we will be forced to either heavily restrict financial innovation or regulate the financial system to make it failure-tolerant. The latter is the better option, but it will be hard to achieve if people believe that greed and fraud were the only causes here.
"The facts that Warren Buffet called exotic derivatives "financial weapons of mass destruction" and state regulators were trying urgently to get reckless mortgage lending under control were just random noise in the system. Uh, huh."
Before we put another halo on Warren Buffett, it's worth remembering that he was and remains the largest shareholder of Moody's (via Berkshire Hathaway), and Moody's was slapping triple-A ratings on plenty of exotic derivative securities, including CDOs full of sketchy mortgage-backed securities. As long as Moody's was using its oligopolistic position to rake in high profits, Buffett doesn't seem to have cared much about how it was earning them.
What are the chances that will happen, when the same banking committee folks who helped caused the problem -- e.g., Dodd and Frank -- negotiated the 'solution'?
Megan,
This isn't really an analysis of causality as much as it is a statement of human cognitive actuality. As such, I find it somewhat dissatisfying.
These biases exist every day and have existed in all of civilization. What makes the last 10 yrs somehow different than the 20 that preceeded it?
i.e. What are the *causes* of the crisis?
Does the market reward rationality and as such modify behavior toward better systems? Does govt influence distort market's self regulating effects or does it serve to cap a system that can never regulate itself? Isn't govt as succeptible to the biases above, such that one would question what makes a public bailout more likely to succeed than any track record of govt interference to date?
Have you just made a case that man is a rational being whose private systems can be trusted in the long run? or that govt intervention and regulation is not only necessary, but critical to reign in the function of private enterprise?
I'm not really sure what you're getting at.
How did it all begin? The drive to allow unqualified people to get loans goes back farther than the last few years when Democrats resisted attempts to regulate Fannie and Freddie.
In a Sept. 1993 Chicago Sun-Times article, Madeleine Talbot (who has been described as a mentor of Barack Obama) led an ACORN initiative to get Fannie Mae to make mortgages for low- and moderate-income people with troubled credit histories. Talbot is quoted as saying "If this pilot program works, it will send a message to the lending community that it's OK to make these kind of loans."
www.nypost.com/seven/09292008/postopinion/opedcolumnists/os_dangerous_pals_131216.htm?page=0
The Clinton Administration’s National Homeownership Strategy formalized these changes, through the Treasury Department and HUD (not through Congress). Clinton expanded the Community Reinvestment Act (CRA), allowed CRA-related loans to include subprime loans, and both allowed and encouraged Fannie and Freddie to hold subprime loans. Here’s a link to an Investor’s Business Daily article on his role:
news.yahoo.com/s/ibd/20080924/bs_ibd_ibd/20080924general01
As banks made more and more subprime loans (which they often had to do because of the CRA, and which didn't seem so risky since many could be sold to the GSEs), people got used to the lower standards and got more and more carried away. When the problem got big enough, the Republicans tried to rein in Fannie and Freddie but the Democrats wouldn’t go along. Here’s a quote from Barney Frank from the House Financial Services Committee hearing, Sept. 25, 2003:
Rep. Frank: I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . . .
Many people are responsible – borrowers, lenders, Wall Street, the credit-rating agencies, politicians on both sides – everyone got carried away. But the bubble got going and the cognitive biases kicked in because the Democrats worked so very, very hard to lower our barriers and convince everyone that lending standards didn’t matter.
Ann,
Who was going to object? The poor were getting loans they didn't deserve and couldn't afford and home owners were seeing their home values go up? What is not to love?
Indeed Ann.
If there is any lesson, it's TANSTAAFL. The barriers were high for a reason.
I agree with everything you wrote, Megan, and frankly, none of it is, or should be, controversial. Nevertheless, I can't accept that this long list of mechanisms by which people fooled themselves somehow makes them blameless, or somehow not really responsible.
I am not looking for someone to blame so that I can say it's Their fault and if it wasn't for Them everything would be rosy. I would like people to be held accountable for believing that the good times were going to keep on rolling, or that, to use the parlance of the previous bubble, "It's different this time." Only a fool could have really thought that creating aritficial demand through easy credit could last forever, that through better evaluation of credit risk and clever new financial instruments, wealth could somehow be created out of thin air. It doesn't surprise me that finance people, who as a group are in it for the money and are not particularly bright, and politicians, who see willful ignorance as part of their job descriptions, would fall down on the job. Nor does it surprise me that homeowners got themselves to believe what they wanted to believe in the quest for wealth or status. Nevertheless, people have a moral obligation to be honest with themselves, and if they get into trouble, saying, "Well, gee, it's natural for people to fuck up. Everyone was doing it. And I really didn't know!" is just bullshit.
Dodd, Frank, the SEC regulators, the bank execs, et al, were greedy, stupid, etc. Better economic understanding won't keep them from finding a way to lie to themselves next time. What you really seem to be saying, Megan, without saying it, is that people can be crap, and you can expect this sort of thing from time to time. Better economic theory would be great. But what we need is better people.
Perhaps I did not state my point clearly enough. Let me try again. Lying and cheating to maximize your own economic advantage is a sh#tty approach to life, even if it is perfectly legal. The collective disutility of such behavior far outweighs the personal advantages attained by the lucky cheaters.
McArdle cannot accept that her basic beliefs are selfish and destructive. That is why she cannot come to grips with the hugely destructive consequences of the ascendancy of similar beliefs in the financial and governmental leadership of the United States.
Well, I agree with understanding cause and effect better. However, your implication then that regulators will be the ones to remove systemic risk (as if only regulators can, and as if anyone actually can) already implies something about what you think the cause and effect was.
Also, searching for cause and effect will necessarily mean that certain actions taken will become in retrospect inappropriate, and may even look stupid. We may also learn that we never, ever, ever want to take such actions again. If that's assigning blame, then how does one actually come to those conclusions without doing so.
I notice Yves at NakedCapitalism is now asserting that liquidity injections make things worse, and that issuing $700B in treasury notes has the potential to suck liquidity out of the credit markets which are supposed to the be the markets we're trying to help.
There is a lot of cause and effect in the last century of free markets and mixed economies that we can rely on. Why are principles learned from those suddenly out the window?
The bailout is a boondoggle. It will only make things worse. What's needed is recapitalization of bad banks by good banks and a change in management. Buying up distressed MBS's ain't gonna do that. Sucking liquidity out of short term credit markets ain't gonna help them. These are cause and effects we can already project.
The specter of "systemic risk" as a mechanism by which to project doomsday and as such make us think that "no action" is "no option" is simply bad thinking. Should we call that "Doomsday bias?"
You said if the bailout doesn't work you'd admit you were wrong. You'll need some tabasco on that hat leather to season it a bit. Come on Megan. Wake up!
I hope McCain will bring these points up in tomorrow's debate. A rescue plan goes against the grain of his base, and he evidently didn't want to mention these things in the first debate. The 'failed poliies of the Bush Adminstration' of Obama has just enough truth to be a good propaganda line.
"Better economic theory would be great. But what we need is better people."
Your economy is only as good as the people who make it up. Where were the exectutives at AIG and Lehman and the like who made these decisions educated? My guess is, but I don't know, that they all had MBAs and finance degrees from elite schools. A lot of people have been saying for years that our MBA schools are producing losers. Maybe it is time to start taking these people more seriously.
Kendell,
What's McArdle getting at?
She's getting at keeping her head up. That's what she's getting at.
She's treading water until she learns the new party line, which she'll then dissimulate with real ability, some grace and the certainty of a true believer.
She can't admit (even to herself, no doubt) that she subscribed to an anti-regulation, hardcore laissez faire philosophy that's proven lately to be an utter disaster for, well, the whole world.
She can't admit that anymore than she can concede that as a financial writer, libertarian ideologue and cheerleader for Wall Street she should be engaged in a bit more self-examination than her mythical reader (who, amusingly enough, we learn in this post, is, ahem, every bit as much to blame as her, her fellow ideologues, and her Wall Street friends! My God! Talk about relativism!)
This, of course, is the reason that while she's living through the greatest financial story of her lifetime she's posting so little these days.
Now don't get me wrong. I enjoy the blog. I frequently find it informative. And McArdle comes across a genuinely interesting, well intentioned and intelligent person. But there's been a real lack of self-reflection these past few weeks that's rather telling. It's indicative of a much more human phenomena than any she describes with those rather silly faux-economics-meets-psychobabble-terms above ("confirmation bias," "hyperbolic discounting," etc.) You know, if she wants to engage in such affected jargon talk she might want to investigate the concept of Denial.
The question should be asked: Where did all this money to lend come from, in the first place? Doesn't life during wartime entail a curtailing of excesses? Perhaps there was a sort of "recency effect": The American economy seemed to grow in spite of the expenditures for the Vietnamese War. However, it should be noted that factories were expanding in the U.S. then, instead of closing and moving production to China. Strong labor unions also made sure that the working class received a healthy share of corporate wealth, which was re-invested in productive enterprises, instead of speculative investments. America should realize that the party is over: Any attempt to prolong it, by federal bailouts, will inevitably lead to the type of hyper-inflation seen in South-American countries where wealth is not evenly distributed.
She can't admit (even to herself, no doubt) that she subscribed to an anti-regulation, hardcore laissez faire philosophy that's proven lately to be an utter disaster for, well, the whole world.
What is the regulation which would have 1) prevented this and 2) made it past Congress? To the extent that such a hypothetical regulation exists, who do you suppose its main opponents would be?
You left out "those who can't do, blog" proud latte sipping jerkwads who if they actually knew anything about economics would be sitting on their own private island somewhere instead of carrying water for the Colonel Klink lookalike who is the Andrew Mellon of our time (strike that, too insulting to Mellon who at least stuck to his radical laissez faire principles), the Carlo Ponzi of our time, and his pet Bernanmonkey.
You're right, it wasn't all our fault, it was YOU and the likes of you's fault. IT WAS decidedly NOT the fault of people like the old bachelor from Yellow Pine, Alabama who merited a small obit in the Gray Lady after bequeathing millions to the University of Alabama-of which he was a dropout as a teenager fighting in WWWII for the country he and others like him made great-from a small fortune he amassed after a life's works in timber and oil. The obit noted he died in the rusting house trailer he lived in for years with a pack of hounds. No latte machine was found therein.
He embodies the men and women wo built this country and the wealth you and the lying, amoral thieves whose bidding you do on this blog every day pissed away like so much Saturday night Coors. Do not moralize to me as you sit in a taxpayer funded Potemkin village surrounded by reality. Why don't you talk about Barney Frank's lover's sinecure at Fannie Mae instead and get off your pulpet? It becomes you as much as the lecherous adulterer Henry Ward Beecher.
She can't admit (even to herself, no doubt) that she subscribed to an anti-regulation, hardcore laissez faire philosophy that's proven lately to be an utter disaster for, well, the whole world.
McArdle is like a Japanese militarist standing in the ashes of Hiroshima. The difference is that the Japanese abandoned militarism. McArdle will have Ayn Rand's greatest hits playing in her head until the day she dies.
We must salute the visionary leadership of the Atlantic in bringing a fanatical libertarian to their blogs on the eve of the collapse of the US financial markets and the socialization of much of our economy. Nothing succeeds like excess.
Virgil Caine (from the song) was an ignorant traitor who supported and fought in a war where over 600,000 Americans died. I believe it was to keep slavery -- you know, to let rich white plantation owners keep exploiting, killing, whipping and raping African-Americans.
Classy!
I'm no fan of Wall Street but compared to that . . . well, they're not even in the same league of evil and anti-Americanism.
Wow, this comment thread degenerated into a bunch of wacko leftists screaming about Ayn Rand and deregulation remarkably quickly...
Somebody should update Godwin's law to take account of the mass-mobs of leftists who swarm any intelligent discussion of the present crisis with uninformed rants about Ayn Rand.
McArdle is like a Japanese militarist standing in the ashes of Hiroshima.
Is it too much to ask that this sort of statement be backed up with something resembling an argument? For instance, you might choose to highlight a particular regulation or generally un-libertarian action which would have prevented the current crisis, and then provide a link to the place where our gracious hostess expressed her opposition.
@ Robbie Robertson:
Either you or me, depending the ability of your chickenshit ass to cash the check your alligator mouth just issued, would be doing serious hospital time if you had the balls to talk like that to my face. I suspect that would hold for most other rural folk in the South whose honest, hardworking NONSLAVEOWNING ancestors you spit on as "ignorant traitors." I reckon that's why you do it on a blog you little sugarbritches you.
Why don't you do some research on the state of Rhode Island's and The Providence PLANTATIONS ill gottem gains from slavery or Chase Manhattan's for that matter, and then shove it up your smug Yankee ass.
Megan: The dramatic increases in a wide host of Federal and Treasury instruments show that people are working, working very hard in fact, to come up with better tools.
Also, looking through the Paulson Plan, it's clear that "punishment" is not high on the Govt's list of priorities either.
And while you've thrown the usual pile of Behavioral heuristics at why the problem occurred, your focus has been on proximate causes, and I'm sure you've noticed that this same kind of bank run keeps happening again and again and again. I have no idea if this has inspired you to reconsider the benefits of term transformation.
Or at least, perhaps you now agree that, in a term transformation system, you essentially have deposits living under the mattress, and the Government lending directly to banks.
-winterspeak
Hmmmmmm, Blighter. I was under the impression Megan identified herself as libertarian (over and over and over again) and even began her blog by taking a (her online) name from one of Ayn Rand's kitsch classics.
Godwin's Law really doesn't count for much if the blogger is a self-professed Nazi who takes his name from Third Reich literature.
Likewise, nailing Megan on the Ayn Rand stuff is pretty legit. That's where she's coming from.
Your logic is thus way, way off.
But, hey, I liked your use of the word "wacko." Was a nice yahoo touch. Worthy of Rush Limbaugh even.
Your failure to understand how regulation is relevant to this crisis is almost endearing too.
@ Robbie Robertson:
Good thing Dishonest Abe freed those slaves in Southern Maryland, Missouri, Kentucky and Delaware when he turned Great Emancipator so they wouldn't be raped and whipped by evil Southerners. Like most "evil" and "anti American Cultural Marxists-such as Dishonest Abe who thrilled to German 48' ers such as the unrepenant Marxist Carl Schurz-your history is as bad as your manners.
That great American, unlike you who wouldn;t know what it means if it bit you on your sorry Yankee ass, Zell Miller was dead right when he said this country would be a helluva lot better off if we made dueling legal again. Good day sir.
Just to settle a few things here. Robbie Robertson wrote that song. A Canadian was writing a song about a Southerner facing losing the war. It is a great piece of art.
As far as the history of it, there were a lot of Virgil Canes in the South. The civil war was very much a rich man's war and a poor man's fight. The Southern aristocricy did and still does consider poor white to be as low or lower than any black. They just sold the poor whites the myth of white supremacy in exchange for staying on the bottom. The real South is nothing like that now. The aristocracy is not what it used to be and most of the people who live in places like Atlanta and Charlotte are Yankees anyway. That is all a good thing because there has rarely been a more loathsome cause than the antibellum South.
Virgil,
I'm not knocking rural Southerners. Or any Southerner.
(Frankly, I'm not filled with regional rage the way you evidently are.)
But I am rolling my eyes at someone who romanticizes a war that got over a half a million people killed. A war to preserve the evil of slavery.
It's the 21st century. Seriously, dude, time to grow up.
Take pride in all the good things rural Southerners have done (literature, music, serving their country with honour, etc.), but let go of the Civil War. It's just pathetic.
Here's an excellent information-packed slide show about the mortgage crisis.
http://thegreatloanblog.blogspot.com/2008/10/depending-on-bailout-slide-show.html
At the peak in 2006, Fannie and Freddie were getting squeezed out of the mortgage market - 56% of mortgages were securitized by private labels, not F & F & Ginnie.
Other scary figures:
Subprime and Alt-A accounted for 33% of mortgages in 2006. Most subprime were ARM's. 1/3 of subprime ARM's were in default in 2008.
To make matters worse:
Credit default swaps (CDS's) are unregulated 'insurance' of securitized mortgages and other debt obligations (with no capital requirements or credit ratings for insurers.) The amount of CDS's out there vastly exceeds the entire US real estate market, so there's a lot of leverage applied to magnify losses. $1T in real estate losses is more manageable than the gigantic CDS overhang.
Regulation:
At this point it seems obvious (to me anyhow) that the role of government should be to exert counter-cyclical pressures on bubbles or panics - which are bound to occur due to human nature (cognitive and emotional biases) as Megan points out.
Or you could look at it this way: There will be government intervention on panics. Therefore the government also has the right and the obligation to intervene to dampen the bubbles, which are the genesis of the panics.
Or you could look at it this way: There is no free market (rational setting of prices) when participants evaluate prices by how they think participants like themselves are going to be evaluating prices now and in the future (bubble/panic pricing.) So regulation in this case doesn't destroy the rationality of the free market, because there isn't any to be found.
When the system uses its own output as the dominant input, feedback destroys the informational value of the external, factual inputs. No free market.
I think that's one fundamental flaw of free market fundamentalism. Rational price-setting relies on negative feedback to converge on the solution to the question "what should the price be?" (e.g. your sales drop sharply as your price goes higher and therefore you get less profit and you lower your prices.) Negative feedback is not always the dominant effect in the system. Where/when this market mechanism fails, I think it is up to the collective - the government - to provide this negative/dampening feedback.
Your failure to understand how regulation is relevant to this crisis is almost endearing too.
It has been difficult to acquire that understanding when all the people pushing the pro-regulation view have declined to identify specifically what regulations would have both prevented the crisis and been acceptable to Congress.
@ Blighter:
You forgot about "wacko" rightists like this old boy. Ayn Rand, McArdle and Lincoln and Colonel Helmut Paulson Klink and his pet Bernanmonkey and the little pissant who disgraced the real Robbie Robertson all deserve each other as traitors to the vision of the great Patrick Henry anyhow. We haven't had a decent President since Andy Jackson took on Biddle, and now the crows are coming home to rip out the eyes of the nation of Aesop's grasshoppers.
CENSOR: I'm done with this shithole, so don't bother me and I'll do the same to you and your'n herein . Enjoy your lattes abnd your Depression.
The tragic aspect of this situation is that fundamentals are actually pretty easy to arrive at for residential real estate (for example, rental costs versus owning costs, or median income versus median house price, have been historically pretty stable.)
So there's been a collective failure, a large-scale looking-away from the fundamentals.
Miss McArdle,
Thanks for a very cogent summary of how people have behaved all my life; and of how this everyday behaviour contributed to this crisis.
There remain two questions:
What fault in the system stimulated the trends that this everyday behaviour magnified?
What corrective factors failed to operate to limit the magnification of the trends?
There is widespread suspicion that the underlying fault in the system is an incentive to bet that the rare disastrous event which in the past has offest a steady run of good profits on a class of transactions will not recur in the near future. The people to whom that incentive applies are the agents manging financial businesses on behalf of the shareholders. If the rare event does not occur during the agent's time at the helm (which is also his peak time at the trough) he or she profits immensely. Not surprisingly, the agent is easy to convince that the rare event is very unlikely in the near future.
If the rare event does occur, the actual loss falls upon the shareholders, and possibly the debtors; but not on the agent.
The expected result of such incentives is that the agents will progressively leverage the businesses they manage, and increase the risks they take in other ways, to take more and more of the routine profit until the rare event occurs. All the factors that you catalogue help them to do just that; in the USA and in Europe.
So far,so bad. The second question is what natural or designed fail-safes failed?
A. The principle of open markets, where participants can weigh and price all the risk, was badly eroded. Great classes of securities were created in which the structure of the underlying risk was obscured. These could not be and were not traded on open exchanges. The double result was poor pricing of the risks, and the addition of individual counterparty risk to the mixture of risks that were not properly priced.
B. The mangers of those agencies trusted to assess the risk on these new classes of securities were subject to the same perverse incentive as the managers of the firms creating these securities.
C. The regulators (with one or two happy exceptions) failed to insist on provision against the rare event, failed to insist on provision against systematic risk (a class of risk overlapping with but not identical to the rare event) in particular did not insist on counter cyclical provisioning, generally failed to insist on capital provision against risks which were formally off-balance-sheet, and failed abysmally in monotoring lending standards.
Conclusions? The elements of human foolishness (hereinafter the McArdle list) would have got us into trouble in any case; but:
1. If the agents managing regulated financial institutions had faced a substantial element of the downside risk to their firms, we would expect the damage to be less than it is.
2. We economists failed to make the regulators aware of the key importance of the risks of rare events, of cycles in the incidence of loan default, and of the power of incentives to erode lending standards. We are listened to; we did not speak out clearly and in time.
3. The accountancy profession failed to make the regulators aware that risks parked off-balance sheet are still risks.
Megan, et al.
You all do realize that just as in everything else, there's nothing new under the sun?
Mises was just as right yesterday as he is today. Just read a little you'd see that he knew where we are headed now as surely as if he had a roadmap.
And all of you ranting about lack of regulation...ROFL...UNREGULATED? The market of the last seventy-five years is only a hair's breadth from fascism and in fact, with the recent bailout - and if things go as Mises predicts they will - The US should be a full-on fascist country within the next five to ten years. Mussolini would be proud.
But, no - Sit around and blame the "greedy bankers" or the "lack of regulation" and beg the state to intervene on your behalf LOL... Here's a hint - the cure can't be the same as the cause.
Now we're all going to get what we deserve.
My only problem is how to explain it to my kids.
Hey -- interns who were supposed to enforce the comment policy? Stop drinking your lattes :) and get to work.
Rob Lyman - I don't know why you keep insisting on knowing which specific regulation might have prevented all this!
The narrative is simple: there was absolutely no government regulation of -- and certainly no government meddling in -- anything at all related to finance, mortgages, lending or the GSEs (yes, yes, they have the word "government" right there in the designation, please try to focus on the bigger picture!) for the last 10 or 15 years.
I'm pretty sure this was the all the fault of Phil Gramm who single-handedly demolished the entire regulatory structure that had been handed down from Zeus aeons ago.
Now, because there was no government involvement of any kind at any level in the creation of this mess, clearly the answer is massive government regulation!
Don't ask me what kind, I'm not some kind of finance whiz.
You see, this was all the fault of greedy, imperfect humans. Once we put some humans who lack human fallibility in power, they'll be able to regulate us right to nirvana!
Yes we can!
Sarbanes-Oxley added another layer of onerous regulatory lard onto an overburdened market. There are a hundred reasons why the meltdown came, but the chief is probably the underregulated Fannie Mae/Freddie Mac which Barney Frank fought to keep free from prying eyes as his friends used FanFred for an ATM to the tune of hundreds of millions---including his "husband" who was VP in charge of handling regulatory supervision by Congress.
If Barney wouldn't enjoy it so much, I'd like to see him frog-marched out of Congress in shackles to a penitentiary where his wildest dreams about walking on the wild side would come true.
If there's a single point of regulatory failure, you can look to the Fed.
Greenspan, as Fed chair, had the power to regulate the mortgage markets but simply did not want to do it, being a free-market fundamentalist (and a Randite to boot :) )
http://www.newsweek.com/id/159346
'Under the Home Ownership and Equity Protection Act enacted by Congress in 1994, the Fed was given the authority to oversee mortgage loans. But Greenspan kept putting off writing any rules. As late as April 2005, when things were seriously beginning to go wrong, he was saying that subprime lending would work out for the common good—without government interference. "Lenders are now able to quite efficiently judge the risk posed by individual applicants," he declared at the time.'
Good analysis.
But I would add the bias towards the market in economic theory to your list. I left the profession a few years back, so my comment might be out of date. But there was a lot of literature devoted towards denying the existence of bubbles. I found it quite annoying, because to me both the stock market bubble of the 1990's and the housing market bubble that just burst seemed to self-evidently be bubbles. And one could point to the bad effects that result when bubbles really go pop. But these points were not so easy to establish when economists could trot out all these models desputing what was self-evidently the case. Their motive in doing so seemed pretty clear: bubbles make it hard to accept the neo-classical model of rationality. (There were economists making the pro-bubble case, to be sure. My frustration was that it ought not to have even been a point in contention.)
Things might be better since there seems to be somewhat more room for psychological factors in the profession now than there was a decade ago. That would be good.
Long story short, though -- there was ideological pressure that kept a lot of economists deliberately blind to the phenomenon of bubbles. Along with the pro-market induced bias, there was also just the 'hey neato, if you use lots of math and statistics you can prove that the self-evident phenomenon doesn't exist' sort of nonsense. That's also a plague in the profession.
I might offer crap mortgages too, if I knew that no matter how risky they were, Freddie or Fannie would guaranty and/or buy them.
So what Megan blames on group-think or the "bandwagon effect," was, in many cases, rational actors, who profited from the irrationality of a bad governmental (or quasi-governmental) policy. These individuals profited, knowing that they didn't need to access the risk of these sub-prime mortgages.
Fannie and Freddie: F&F lost market share as the subprime bubble expanded.
Securitized mortgages were being marketed as 'low risk' because they were tranched and insured by CDS's - and because the model said so. Not because the government said so.
In 2006, 'private label' (non F&F&Gm) mortgages were 56% of the subprime pile.
Regarding home prices increasing; Yes they tend to go up reliably, but in the past 5-6 years in some markets home price increases were on steroids. People believed prices would continue increasing even when the affordability level was far beyond an average buyers means already. Either they believed or thought they could bail before getting caught. When prices reach the level where only about 10-15% of the potential buyers can afford a house, expect a correction.
Here's a bit of regulation, just off the top of my slightly-above-average-understanding-of-current-economics brain, that could have either prevented or abated this crisis: Don't let the credit rating agencies be financially tied to the products they are rating, to the point that it directly benefits them financially to ignore prudence and inflate the safety of the product. Would this situation have happened if mortgage-backed securities had not been rated as cash-safe? Would they have been rated such by the agencies if there hadn't been such great monetary incentive for them to do so? I attach this to the admission of my limited knowledge because there comes a point when simple common sense needs to be injected into the equation.
Sure, we can avail the ratings agencies of blame to the extent that they were relying on the same bad data as every other financial player in the bubble. But to equally implicate ordinary American homeowners trying to make a profit on house flipping is ridiculous and shameful beyond belief. Economic conditions are created, controlled, and manipulated by those in power--politicians, Wall Street executives, and the like. Average people participate in the economic situations CREATED by these entities. When "market forces" (i.e. the wills and whims of investment banks wanting to capitalize on the huge demand coming from the global pool of money) formulate an economic landscape, and the "fundamentals of our economy" out there keeping the wheels of capitalism greased choose to participate in said landscape, how can you possibly hold them equally accountable? Who creates the situation, and who dutifully participates with the faith and trust that credit markets, acting in their best interests, won't give them more loan than they can handle?
When credit lending standards slackened in the 90s and creditors realized they could make the greatest profit off of those least able to pay, do you think average Joes getting five card offers per day immediately attributed this to the greed of the markets? Or did they feel some pride, some false sense of accomplishment, operating under the assumption that lenders acted as they did for decades and lent in direct relation to risk?
You can't blame the ants that invade your kitchen when you leave crumbs all over the floor, unless you are just flagrantly irresponsible and unwilling to examine your extremely flawed grasp of the dynamics at play.
Who creates the situation, and who dutifully participates with the faith and trust that credit markets, acting in their best interests, won't give them more loan than they can handle?
Good Lord, are you really suggesting that it's the lenders' responsibility to keep idiot borrowers out of trouble? Who knows more about your finances, you or the bank?
You can't blame the ants that invade your kitchen when you leave crumbs all over the floor
True, but I for one am hesitant to compare the average American to an ant.
I would add to the standard cognitive errors the specific phenomenological view of the global financial system as a whole greater than the sum of its individual parts, when in fact the whole is likely equal to the sum of its individual parts. Thus the delusion that getting rich without doing commensurate work was possible. Also a conceit which followed from that view, that in the global system America could grow economically as a nation of consumers of goods made elsewhere, in essence by producers who were "working for us." Thank you for writing a really thought stimulating post.
"As late as April 2005, when things were seriously beginning to go wrong, he was saying that subprime lending would work out for the common good—without government interference."
If Greenspan was against government interference, why was he calling for more government regulation of Fannie and Freddie?
As far as a major figure claiming that subprimes would work out for the common good, perhaps the reporter confused Greenspan with Barney Frank.
I strongly suspect >90% of people are above-average drivers, less likely to get into an accident than the average joe.
Similarly, more than 90% of people have an above-average number of legs.
A lot of commenters are missing a basic point about hardcore libertarians: they believe that people are rational creatures and therefore markets will obey natural laws and thrive in the absence of regulation. McArdle's entire post runs directly contrary to that world view. She argues that the current crisis was caused by irrational behavior, and she explicitly calls for better regulation. Anyone who claims the post was a defense of deregulation is either an idiot or a troll.
Rob Lyman - I, too, would hesitate to compare the average American to an ant. However, when the homeowndership level rises from 63% or so up to 68% or so, those marginal 5% are not "average" Americans. They are, almost by definition, below average in credit worthiness at the very least.
Credit worthiness is, I would imagine, very highly correlated with knowing about your own finances. Thus, in terms of being able to accurately evaluate thier own ability to handle these loans, these folk probably were operating at about the level of ants with bread crumbs.
I share Katie S.'s disgust at the system that allowed the rating agencies to hold an "official" and semi-regulatory capacity while at the same time effectively selling ratings on the very toxic assets at the heart of this crisis. It's particularly galling to watch them now hammer the credit ratings of the very firms who made bets based at least in part on those fraudulently sold CDS ratings.
Some kind of regulation to severe the ratings agencies from being able to sell ratings for would be welcome.
MikeF: "Anyone who claims the post was a defense of deregulation is either an idiot or a troll."
Or both...
As I Posted at Redstate.com:
RE: Fanny, Freddie and Who Should Own A Home:
I have very conflicted emotions about this, and the conservative/Republican vs. liberal/Democratic “pundits” aren’t making it any clearer to me where the fault lies. I suspect that there is enough blame to cover everyone. The fact is that I could never have bought my home if not for FHA (and I don’t know how that relates to Freddie/Fannie, but I do know its a Federal program to help those like me to buy a home). At the same time, I had to come up with a decent (10%, plus closing costs… etc) to buy. When the “re-finance! get cash now!) trend started, I did refinance… AT A FIXED RATE!
I asked questions… I did my homework… I put my “lending agent” on the spot BEFORE I signed any papers. So, while I am equally angry at borrowers who pretended they didn’t know they were buying homes they couldn’t afford (especially when “ADJUSTABLE” rate should have clued them in), I am equally angry about trying to pin this on Federal programs designed to help those of us without a lot of capital to get into our first home. Yes, there are some folk who should not have been given the credit to buy homes. But, is this the problem of those folks (I’d say yes) or the financial institutions who created exotic “investment instruments” in order to make it possible to buy a house with Zero Down! Choose to pay Principal or Only Interest! (again, I’d say yes).
It feels like everyone is to blame, but both Conservative and Liberals want to pin it on one party (the other, obviously) when that isn’t reality. The truth is EVERYONE, from law-makers to markets to banks to debt salesman/bundlers to realty ’specialists’ to the home-buyers are at fault. Everyone decided that reality no longer applied because, somehow, home prices would just go up forever and ever and ever, despite the fact that has never happened in the history of ever.
To say it was the democrats fault for enabling Freddie/Fannie or that it was the Republicans fault for loosening/eliminating oversight is both correct and wrong. The system worked together to bring us this mess and there is too much blame to worry about proportioning. You all need to stop being partisan about it, because both of your chosen parties have mud on their faces this time.
there is too much blame to worry about proportioning.
False. Some players deliberately misrepresented risk. This is called fraud. They should be punished. Dishonesty should be punished according to the harm it causes. The harm has been enormous.
The fact that not a single person has been jailed for the greatest collective theft in American financial history is an appalling failure of our society.
This article and pretty much all of the msm coverage of the financial crisis really does miss seeing the forest for the trees.
The catalyst -- again catalyst -- for the financial crisis was defaults in the residential mortgage market.
Some forest vs. tree numbers: The U.S. mortgage market is roughly $15 trillion (both residential and commercial). Less than 8% of this is now either delinquent or foreclosed - or around $1.2 trillion.
I.e. the near term actual / anticipated losses from commercial & residential mortgages is around $1.2 trillion. The global financial sector is not now "frozen" or "in a panic" over $1.2 trillion. That amount is dwarfed by capital injected over the last year by private investors and via public "liquidity" measures.
I've seen estimates that if we have a depression and housing pricing go down another 20% in a very bad scenario this could reach 20% or $3 trillion. Again, $3 trillion is not causing the panic.
Our current problem is a complete collapse in trust / confidence in the global financial system. A classic bank run. Only instead of individual depositors withdrawing, this time it is banks, hedge funds, pension funds and other institutional investors.
We do not have a "liquidity" crisis. Treasury rates are now negative. I.e. investors are paying the U.S. government to hold onto their money. Interbank lending rates are at crazy levels.
Why has there been a complete collapse in confidence? There is a $70 trillion credit default swap market that has always been completely speculative. It has no capital backing it up. And no one knows where that daisy chain goes. The CDS market is just the largest of the opaque and dubious "asset" classes on the balance sheet of global banks.
The panic this time is on the part of the insiders -- the principals of the global financial system. They are panicked because because the models that value their "assets" have proven to be flawed -- and they leveraged these "assets" by a factor of up to 40.
There must be some effort to accurately describe the problem before affixing blame. Even worse is to intimate that since all deserve a sliver of blame, those that caused the lion's share of the problem do not deserve to be singled out.
Greenspan's very well known as a free-marketeer, and his call for regulation of F&F (to limit their size, not the mortgages they would accept) is a real exception for him.
Best guess is that he wanted to rein in the size and activities of F&F since they were not really free-market entities (being quasi-governmental) and therefore presented competition to banks and I-banks.
Not very severe competition, since by 2006 the banks and I-banks were winning the stupidity competition in subprime mortgages anyhow.
It is a source of no small amazement to me that the Congress and the President seem to think the proper way build to confidence in markets is by ramming the bailout down the throats of those whose confidence matters, thus destroying the very confidence they should have sought to build. Maybe they bought the confidence of their peer elites, but they pretty much destroyed the confidence of the rest of us.
It is a source of no small amazement to me that the Congress and the President seem to think the proper way build to confidence in markets is by ramming the bailout down the throats of those whose confidence matters, thus destroying the very confidence they should have sought to build. Maybe they bought the confidence of their peer elites, but they pretty much destroyed the confidence of the rest of us.
do you get paid by the word?
sure seems like it.
the causes of the current crisis are simple:
1 - LOOSE MONEY - too much lending to too many people who were not very credit worthy. despite worries this went on from 1995-2007.
2 - the central banks then RAISED RATES from 2004 to 2007. they suckered folks in with low rates them raised them. both the usa fed and the ecb did this.
3 - the enormous increase in the price of crude = from 2006-2008 greatly slowed the growth rates of ALL the west's economies.
if the democrats had not blocked the gop from getting more oversight of fannie and freddie, and if the central banks had not raised rates (greensapn did is 17 times from 2004-2006!)m ad if oil had not gone from 70/barrel to 145/barrel, then this financial meltdown wouldn't have ever occurred.
all we need to do now is reduce the price of money to 1.5% and increase downward pressure on oil by drilling here now, and licensing several nuke power plants and coal plants right now.
and clamping down on fannie and freddie.
credit is not a right.
especially not for uncreditworthy folks.
this also illustrates why BIG GOVERNMENT SUCKS:
big programs cost big dollars and those dollars don't belong to the politicians who control them. and they don't usually need the programs, wither.
so they are very6 susceptible to bribes of one sort or another from interest groups who want a slice of that BIG MONEY.
private firms watch their own money better than the politicians watch ours.
or as reagan said: we know how to spend our money better than dc does.
do you get paid by the word?
sure seems like it.
the causes of the current crisis are simple:
1 - LOOSE MONEY - too much lending to too many people who were not very credit worthy. despite worries this went on from 1995-2007.
2 - the central banks then RAISED RATES from 2004 to 2007. they suckered folks in with low rates them raised them. both the usa fed and the ecb did this.
3 - the enormous increase in the price of crude = from 2006-2008 greatly slowed the growth rates of ALL the west's economies.
if the democrats had not blocked the gop from getting more oversight of fannie and freddie, and if the central banks had not raised rates (greensapn did is 17 times from 2004-2006!)m ad if oil had not gone from 70/barrel to 145/barrel, then this financial meltdown wouldn't have ever occurred.
all we need to do now is reduce the price of money to 1.5% and increase downward pressure on oil by drilling here now, and licensing several nuke power plants and coal plants right now.
and clamping down on fannie and freddie.
credit is not a right.
especially not for uncreditworthy folks.
this also illustrates why BIG GOVERNMENT is lousy:
big programs cost big dollars and those dollars don't belong to the politicians who control them. and they don't usually need the programs, wither.
so they are very susceptible to bribes of one sort or another from interest groups who want a slice of that BIG MONEY.
private firms watch their own money better than the politicians watch ours.
or as reagan said: we know how to spend our money better than dc does.
do you get paid by the word?
sure seems like it.
the causes of the current crisis are simple:
1 - LOOSE MONEY - too much lending to too many people who were not very credit worthy. despite worries this went on from 1995-2007.
2 - the central banks then RAISED RATES from 2004 to 2007. they suckered folks in with low rates them raised them. both the usa fed and the ecb did this.
3 - the enormous increase in the price of crude = from 2006-2008 greatly slowed the growth rates of ALL the west's economies.
if the democrats had not blocked the gop from getting more oversight of fannie and freddie, and if the central banks had not raised rates (greensapn did is 17 times from 2004-2006!)m ad if oil had not gone from 70/barrel to 145/barrel, then this financial meltdown wouldn't have ever occurred.
all we need to do now is reduce the price of money to 1.5% and increase downward pressure on oil by drilling here now, and licensing several nuke power plants and coal plants right now.
and clamping down on fannie and freddie.
credit is not a right.
especially not for uncreditworthy folks.
this also illustrates why BIG GOVERNMENT is lousy:
big programs cost big dollars and those dollars don't belong to the politicians who control them. and they don't usually need the programs, wither.
so they are very susceptible to bribes of one sort or another from interest groups who want a slice of that BIG MONEY.
private firms watch their own money better than the politicians watch ours.
or as reagan said: we know how to spend our money better than dc does.
do you get paid by the word?
sure seems like it.
the causes of the current crisis are simple:
1 - LOOSE MONEY - too much lending to too many people who were not very credit worthy. despite worries this went on from 1995-2007.
2 - the central banks then RAISED RATES from 2004 to 2007. they suckered folks in with low rates them raised them. both the usa fed and the ecb did this.
3 - the enormous increase in the price of crude = from 2006-2008 greatly slowed the growth rates of ALL the west's economies.
if the democrats had not blocked the gop from getting more oversight of fannie and freddie, and if the central banks had not raised rates (greensapn did is 17 times from 2004-2006!)m ad if oil had not gone from 70/barrel to 145/barrel, then this financial meltdown wouldn't have ever occurred.
all we need to do now is reduce the price of money to 1.5% and increase downward pressure on oil by drilling here now, and licensing several nuke power plants and coal plants right now.
and clamping down on fannie and freddie.
credit is not a right.
especially not for uncreditworthy folks.
this also illustrates why BIG GOVERNMENT is lousy:
big programs cost big dollars and those dollars don't belong to the politicians who control them. and they don't usually need the programs, wither.
so they are very susceptible to bribes of one sort or another from interest groups who want a slice of that BIG MONEY.
private firms watch their own money better than the politicians watch ours.
or as reagan said: we know how to spend our money better than dc does.
do you get paid by the word?
sure seems like it.
the causes of the current crisis are simple:
1 - LOOSE MONEY - too much lending to too many people who were not very credit worthy. despite worries this went on from 1995-2007.
2 - the central banks then RAISED RATES from 2004 to 2007. they suckered folks in with low rates them raised them. both the usa fed and the ecb did this.
3 - the enormous increase in the price of crude = from 2006-2008 greatly slowed the growth rates of ALL the west's economies.
if the democrats had not blocked the gop from getting more oversight of fannie and freddie, and if the central banks had not raised rates (Greenspan did is 17 times from 2004-2006!)m ad if oil had not gone from 70/barrel to 145/barrel, then this financial meltdown wouldn't have ever occurred.
all we need to do now is reduce the price of money to 1.5% and increase downward pressure on oil by drilling here now, and licensing several nuke power plants and coal plants right now.
and clamping down on fannie and freddie.
credit is not a right.
especially not for uncreditworthy folks.
this also illustrates why BIG GOVERNMENT is lousy:
big programs cost big dollars and those dollars don't belong to the politicians who control them. and they don't usually need the programs, wither.
so they are very susceptible to bribes of one sort or another from interest groups who want a slice of that BIG MONEY.
private firms watch their own money better than the politicians watch ours.
or as reagan said: we know how to spend our money better than dc does.
Like an Ayn Rand replica talking doll, she keeps chirping away about how swell everything is when government stays out of the way.
McArdle will have Ayn Rand's greatest hits playing in her head until the day she dies.
Likewise, nailing Megan on the Ayn Rand stuff is pretty legit. That's where she's coming from.
Well, when you're left of Castro, even McCardle might look like Ayn Rand. But McCardle is no Ayn Rand or Objectivist, not even close -- enough to make her use of the "Jane Galt" handle blatantly dishonest.
At least get your target right before you spout off. Credit where credit is due!
[McCardle] argues that the current crisis was caused by irrational behavior, and she explicitly calls for better regulation. Anyone who claims the post was a defense of deregulation is either an idiot or a troll.
Little Girl: "What we need is better economic theory of how these things play out,..."
The Austrians have been on the bookshelves for over a century.
Twit.
The efforts here to be ever so "even-handed" and "objective" would be amusing were they not so tragically misguided. The Democrats (and some, but not many Republicans) long ago abandoned Judeo-Christian morality as found in the 8th and 10th commandments. (That's "Thou shalt not steal," and "Thou shalt not covet" for those in Rio Lindo.) "We" do not all deserve the blame equally. More importantly, until we stop legislating theft, irresponsibility, and "something for nothing" entitlements, we will see more crises in the future. The failure here is government failure, just as the Great Depression was a government failure. But since we, or some of us, will keep re-electing the Frank's and Dodd's and Obama's who promise everything, and understand nothing, prepare for the worst. This is but a dress rehearsal for the mortgage re-sets of 2010 and the bankruptcies of Medicare and Social Security ca. 2013. Happy Thanksgiving and Merry Christmas.
All the above listed reasons simply explain why bubbles inevitably follow speculative frenzies. However, some speculation is at least plausible. During the Internet Boom years, it was plausible that productivity enhancement from all this sudden global connectivity and availability of insta-information would transform the world (Dow 36000!)
The real estate bubble, however, makes absolutely no sense. There is no innovation. People were betting on increased consumption, payable over 30 years, and funded by decreasing incomes! All the financial jugglery and derivatives chicanery seems to have led some bankers to delude themselves, too, in the process. In examining the data with a fine tooth comb, they seem to have forgotten a simple, unequivocally limiting factor: Middle America, while devouring real estate, has insufficient means to pay for its crazy consumption. Of course, the number of non-demented, capable-of-work years are increasing now, but the market was surely not accounting for the extra decade or so of possible individual income streams (that would have required Americans pushing the retirement age further, like McCain).
Maybe they should employs climatologists, whose computer models are infallible.
This isn't about 'cognitive error' Megan. This is a classical Austrian business cycle popping. Alan Greenspan inflated the money supply and that's why everyone made errors.
Increasing the money supply always makes people think they are getting rich because that's the purpose of money in the system, to send economic signals.
When you lower the time cost of money, interest, below the market price for so long the result will of course be error. Just like if you set the market price of gasoline below market prices. Consumers, borrowers, consume to much and producers, savers, produce to little.
The normal result of price ceilings is a shortage. Unlike most other prices interest is a price differential between the present and the future. So it actually takes a long time for the shortage to be exposed.
Another unfortunate effect of this kind of price control is that it doesn't effect just one good like a floor on the price of wheat, or a ceiling on rental rates. It effects ALL goods and services. It causes overinvestment in goods far from consumption and underinvestment in good close to consumption.
This distortion in the economy results first in the rise of long term capital goods (think internet companies, commodities, houses) and later works it's way into consumer goods.
Eventually the error is esposed and the long term goods (houses) are shown to be overpriced because of the artificially low rates. In fact, consumers really didn't want that many long term goods (houses) and actually prefer short term consumer goods. Which eventually rise in price.
Without additional injection of capital the boom will go bust, but with repeated injection it just goes bust in a bigger way.
We reflated after the internet bubble and that just caused another bubble in housing. Now are markets are worse than if we just had let the economy recover without lowering interest rates to 1% after the last market crash.
All the 'cognitive errors' are mere effects that always come with monetary inflations. Happened during tulip mainia, south sea bubble, and every monetary mania.
What other signal can people use than money? Are they suppose to know Austrian theory and realize that their profits will evaporate in an unpredictable manner perhaps 10 to 15 years down the road? Surely you don't expect people to wait it out for that long.
In my opinion there is no rational way to behave in a mania. Seems perfectly rational to accept a $21 million dollar bonus and behave riskily when money is pouring in hand over fist.
Note that everyone acted according to what was rational for them to do. Playing "hot potato" with debt meant that nobody cared if the debt was bad. Nobody had any skin in the game. No regulation would have been required if people at each stage would have lost money if their debt was bad.
That said, I think my description of what happened is more useful:
http://proheretic.geekuniversalis.com/2008/10/02/the-economy-where-we-are-why-were-here-and-the-future-part-1/
-Ray
If lack of regulation was the problem, why is Europe getting sucked into this, also? Aren't they more regulated than we are?
There is also the effect of big investors influencing markets as they come in. Take CALPERS as an example. Through their political influence the state employees (As one example) have accumulated about a trillion dollars for their retirement. There are a lot of other people who think they are going to enjoy super well funded retirements. When they go to invest their wealth claims in the real economy it is likely they will, out of economic necessity, get screwed. Using these dollars to purchase the assets and economic output of the real economy, they will unavoidably bid up the price of anything they invest in. This definitely happened in the current crisis. It's a variation of "If you have a hundred dollars to invest, good for you, but if you have a hundred trillion to invest, good luck with that." CALPERS already took a bath on this crisis, and I predict they will be spritzed some more as they attempt to invest these gargantuan funds path forward. People holding dollars and lenders of dollars can only be repaid in goods and services by productive free agents who ultimately will decide what they consider fair. Rule of law, combined with free markets does not extend to economic slavery. There is a breaking point, and we are approaching it. As a Gedanken, imagine everyone in the nation is retired, and only one guy actually works running the productive economy through say, massive automation and skill. Call it "Oneguyco". What is stock in his company going to cost? Who decides what is fair?
Talking about 'regulation' is much like conversing about 'torture'. Everyone has their own definition and bright line.
There is one flaw in this analysis. Around 1991 there was a significant sag home prices in California. I believe it was happening elsewhere in the country also. My house went from 250K at the peak to 187K when I sold it. (Not a problem for me as I had plenty of equity and moved upward, best done when prices have dropped).
Thus there is no excuse for any but the youngest buyers not remembering that bubbles end.
To complete my thought above:
Combine what I said about a bubble that everyone should have seen with TheWesson's observations that there are well known fundamentals that apply to the residential housing market, and you get the answer to what the mortgage companies (or the regulators) should have done.
As the prices became higher than normal and a bubble acknowledged, down payments should have been required, and appraisal techniques scrutinized.
It is dangerous to have the government decreeing what they think a normal price is, therefore the mortgage companies should have been coming up with some algorithm for the sake of their own defense against a bursting bubble.
One technique would be to require a down payment that is proportional to the difference between the theoretical reasonable price based on fundamentals vs the market price. An increasing down payment requirement would have created a soft landing for the bubble (before it became a real bubble).
However, the discipline to turn away business as fewer people qualify is hard to stick with as you observe the company down the street making big bucks writing marginal/dangerous loans.
That challenge of remaining prudent while you see great profits by the other guy doing reckless deals also played a part in the dot com bubble and the cases of executives cooking the books to "keep up with the Jones's" business down the street.
To avoid governmental decrees about business in the private sector, the mortgage industry should form a "standards group", much like the ones that exist in the electronics and other industries, to formulate a handbook of accepted practices regarding mortgage qualifying and how to rate the risk of mortgages for the purposes of resale to the secondary market.
I think an alternative exists already: the constraints imposed by mortgage insurance companies when mortgage insurance is desired for a loan.
Which brings the question: why weren't the mortgage insurance requirements putting a damping effect on the market? Maybe the mortgage companies quit requiring mortgage insurance?
If we can't blame this on a particular party, can we at least blame it on a region, like California? :)
Which brings the question: why weren't the mortgage insurance requirements putting a damping effect on the market? Maybe the mortgage companies quit requiring mortgage insurance?
There are a lot of ways to avoid PMI, like an 80/20...
McArdle simply cannot associate greed with wickedness.
Nor can McArdle associate effect with ultimate cause: Many hundreds of words to, again, avoid the nub, which is a fractional reserve system spread to the globe.
Today monetary systems with money supplies kite units of Keynesian fiat debt-currency onto an enormous world-wide cantilever of pure debt and limited trust. The system is thereby tailor made for abuse.
At its top, formerly, was that old fool Greenspan, who went right out and repeated Japan's mistake of near-zero interest and heaps of currency -- when money is actually fiction and 100% debt, you can do that, especially when folks call you a maestro.
So there's that other little issue of making money of thin air, but as goes dissociating greed from wickedness so goes dissociating greed from opportunity. Yet it was opportunists that created fractional reserve decades ago.
Today we'll live to see how it ends. Once it goes exponential, it cannot survive long.
McArdle's analysis is as if to explain the entire demand-side drug problem without ever once mentioning its supply and suppliers -- the Fed and Helicopter Bernake. For which we depend on McArdle to be McArdle and for which we depend on those afraid to point at naked Emperors to abridge the big story.
Trying to abstract the causes of this into "cognitive errors that affected everyone" is the surest way of making certain it happens again. For the last five years loads of people from James Howard Kunstler "The Long Emergency" to Paul Krugman, George Soros and Salon's Andrew Leonard have been screaming that this very thing was going to happen. Pretending that it all just materialized out of some quantum foam of inescapable human error is a thin and frankly unconvincing argument at this point.
Causes from the bottom up:
* People with low income and poor credit want to own homes, rather than rent.
* Builders and realtors want to sell anyone a home, as long as they don't hold the mortgage.
* Politicians with low-income, unqualified potential home buyers, mostly black and Latino, want to create another vote-buying program. They know the amount of money involved will attract a lot of lobbyist and PAC money from builders, mortgage brokers, bankers, bond packagers, etc.
* Politicians create new legislation to subvert FNMA and FMAC to assume risks of new high-risk mortgages, called "subprime".
* SEC buys into new bond packages for sub-prime mortgages. Just as market saturates in US, political worries in the rest of the world drives investors into these junk bonds.
* Lobbyist money flows to Barney Frank, John Spratt, Nancy Pelosi, Chris Dodd, along with some discounted mortgages to Dodd and Frank.
* Janet Reno issues public threat to banks not to use "discriminatory profiling" by asking for proof of income, employment history or repayment history.
* Boards of Fannie Mae and Freddie Mac become loaded with political cronies lacking expertise, 60% of them from Clinton, like Harold Raines, Johnson, Louis Freeh, Jamie Gorelick, Rahm Emmanuel. They don't know the business, and are easily manipulated from Wall Street above and bureaucracy below. They are paid $577,000 salaries and $700,000 bonuses to do nothing.
* During Clinton years, sub-prime mortgages increase from 2% to 20% of all new mortgages.
* Big mortgage producers like Golden West, WaMu, Countrywide and others begin to have problems. FNMA and FMAC boards issue fraudulent reports of profits of $5 BILLION to $6.9 BILLION, when they are actually losing money. Boards collect huge bonuses.
* Politicians spin to protect FNMA and FMAC, and block reforms proposed by President Bush in 2002 through 2006. Democrats block every reform. Voting is along party lines to block bills in committee.
* Finally, at the 11th hour, Congress is forced to respond before the election. Without any hearings, meetings, analysis or debate, they give a blank check to the Treasury Department for $350 B, then $500 BILLION, then 600, 700, 710, 810, and then $850 BILLION.
* Pelosi and Frank announce late Friday Oct 3 that, "This is just the beginning", and there will be more after the elections. On Monday, the Dow responds with an 800 point drop.
People who think this speculative housing bubble was largely the result of actions taken in the last ten years are are very mistaken. The seeds of this bubble were sown long ago, and resulted in all manner of perverse incentives, incentives that gradually built over time until they became overwhelming.
People who speak of this bubble, in a market as heavily influenced by state action as the U.S. housing market, being proof of the failure of free markets are very, very, very, mistaken.
There are a lot of ways to avoid PMI, like an 80/20...
That would not have worked when I bought my first home, in 2000. They examined the sources of my 20% down payment (stock sales and cash savings) VERY carefully. They were particularly interested to discover if any family were loaning me money disguised as a "gift," meaning that my payment obligations would have been higher than the paperwork showed.
At one point, I protested to my loan officer that I was a legitimate olive oil importer, and they should leave me alone.
The very existence of the 80/20 plan shows that the underwriters were not paying adequate attention, and I doubt you'd get away with it today.
The real "madness" is how we're dealing with this now.
"McArdle simply cannot associate greed with wickedness."
Exactly!
The Republicans have not one policy tool to stop it or effectively harness it. If taxes are always bad, and everything the market does is good, i.e. their self-regulating, how do you prevent bubbles? Tax cuts don't work. Starving regulatory agency budgets don't work. The Fed is independent. Further, its a poor excuse to abdicate fiscal policy to monetary policy.
We dont need any new economic theories; we just need the Republicans to wake up out of their state of denial. Government must play a role. There are cases where it must to raise taxes, i.e. war. There are situations where we need to strictly and consistently enforce the laws on the books, i.e capital requirements. Business and household decisions do not always optimize overall economic security.
I thought you were supposed to know something about economics? What we have here is luke-warm apologies for advocating a system that led to disaster. We are supposed to believe that this advocacy held no responsibility or culpability for its advocates.
Sorry, m'am. We are responsible for our behavior. And you are too.
The reaction of the credit markets to the failure to bailout Lehman showed that the market players were expecting a bailout. The real analysis needs to take into account the real world implications of government interventions in financial crises. Without a clear understanding of what that role will be, it's hard to know exactly what investors are relying on in making many of their decisions. If they're assuming government intervention, one can assume that their decisions are different than if they weren't.
Megan,
Sorry to be a stickler, but your use of hyperbolic discounting is incorrect: you're using it as simple discounting. The kicker with hyperbolic discounting is that the same intertemporal choice would be reversed if, instead of choosing between today and tomorrow, the decision happened further down in the future (tomorrow vs the day after tomorrow).
The problem with bonuses is not one of rationality: it is a simple principal/agent moral hazard incentive issue caused by the different profiles in the return to the trader (end of year bonus) and the return to the investor (beyond the bonus). Arguably, they could both have the same discount factor.
RAM
Megan,
One point to clarify. The "revolution in credit scoring" happened so long ago (late 80s/early 90s) to make it irrelevant to the recent housing bubble. As you accurately point out, lenders assumed ever-increasing home prices in their risk models but the consumer credit information fed into those models was not a recent innovation.
Despite your attempt to blame Asian lenders and nations for the Fed's loose monetary policies after 9/11, that argument doesn't hold water. While Greenspan blithely insisted that the Fed's mandate to control price inflation doesn't include asset bubbles such as stock and housing bubbles, the U.S housing bubble continued to inflate on his watch. At some point he will have to convincingly explain why kept monetary policy loose through 2003 and 2004 (perhaps as part of Bush's reelection strategy?) when he'd taken steps in the late 90s to tighten credit, reducing the stock market bubble. Pretending that all parties were innocent bystanders to forces beyond their comprehension and controls rings a little false considering the past praise of Greenspan's record at the Fed.
To say that it's the Democrats who have "a blind belief in homeownership for poor people" and that President Bush wanted to restrict the mortgages of FNMA and FMAC is flat out wrong. Excerpts from Bush's remarks to HUD in June 2002:
"I've set this goal for the country. We want 5.5 million more minority homeowners by 2010."
"[P]robably the single barrier to first-time homeownership is high down payments...And so I've asked Congress to fully fund an American Dream down payment fund which will help a low-income family to qualify to buy."
"The second barrier to ownership is the lack of affordable housing...The best way to do so, I think, is to set up a single family affordable housing tax credit to the tune of $2.4 billion over the next five years to encourage affordable single family housing in inner-city America."
"The third problem is the fact that the rules are too complex...So one of the things that the Secretary is going to do is he's going to simplify the closing documents and all the documents that have to deal with homeownership."
"Finally, we want to make sure the Section 8 homeownership program is fully implemented. This is a program that provides vouchers for first-time home buyers which they can use for down payments and/or mortgage payments."
"It is essential that we make it easier for people to buy a home, not harder."
"We need more capital in the private markets for first-time, low-income buyers. And I'm proud to report that Fannie Mae has heard the call and, as I understand, it's about $440 billion over a period of time. They've used their influence to create that much capital available for the type of home buyer we're talking about here. It's in their charter; it now needs to be implemented."
The full text of his remarks can be read here:
http://www.whitehouse.gov/news/releases/2002/06/20020618-1.html
* Politicians spin to protect FNMA and FMAC, and block reforms proposed by President Bush in 2002 through 2006. Democrats block every reform. Voting is along party lines to block bills in committee.
hmmm. funny the democrats were able to block all these reforms, precisely during the years where they were IN THE MINORITY.
But of course, no matter what happens, it must be the Democrats fault.
Eric,
You are guessing, throwing out vague assertions as if you know the details, which you don't.
Why don't you read the actual votes on the 18 occassions Democrats stopped reforms of FNMA and FMAC? You will see that they were unanimous or nearly unanimous on almost every vote, needing only a few Republicans to block passage. In the last 2 years, Democrats have been the majority in both houses and blocked legislation in committee by unanimous partisan votes.
I hope the last statement is meant to be ironic.
"Because, after all, we know that it wasn't us who was at fault. We're just the victim of broad market forces outside our control."
As for "What we're looking for is not better tools, but someone to blame." -- the tool of common sense would be useful.
"What we need, fundamentally, is not simply stricter regulation or less greedy bankers. What we need is better economic theory of how these things play out, so that the regulators have better tools to assess and prevent systemic risk."
Except we already knew from centuries of economic history that markets are subject to catastrophic failure as a consequence of various forms of human irrationality.
There were many economic rationalists who warned the last few years that we were on the road to disaster. The group to blame is the economics profession as a whole, which is supposed to be on the lookout for irrational thinking, but instead encouraged it.
Speaking of which, Megan, which group were you in the last few years, the rational one or the irrational cheerleaders? And if you were wrong, have you learned anything?
Eric, You are guessing, throwing out vague assertions as if you know the details, which you don't.
Come on. all I said was that it was strange the Democrats could block something when they were in the minority. It's indisputable that they were in the minority during the time period that you refer to. That isn't a guess.
This is why your side is losing the argument. Its hard to argue that something is the democrats fault when Republicans have controlled congress for 12 out of the last 14 years, and the presidency for the last 8.
In our estimation of probabilities, there is also the possibility that someone cheated.
For example, you see someone flipping a coin. for a few times in a row, it always comes up head. What is the probability of it coming up head the next time he flips it again?
answer: 100%. There is definitely something wrong with the coin.
We are often to think in terms of probabilities to overcome our own evolutionary shortcomings to help us better understand the world's chaos. However, we often disregard that there are other real people in this world who often "cheat". In some part, this whole mess was helped along by a confluence of various "cheaters"; lobbyists, politicians, bankers... And there on both sides of the isle.
The references to Rand and the Austrians.
"Mises was just as right yesterday as he is today. Just read a little you'd see that he knew where we are headed now as surely as if he had a roadmap."
Sorry, von Mises and the Austrian school were also ethical as was Adam smith. The present day American (or other)freemarketers, including the Republican (possibly many Democrats too)leaders are totally amoral and are concerned about peripheral issues like gay rights and and unconcerned about their greed bleeding the society. Absolutely no comparison! A free market system should be based on ethical behaviour too!And that has been lost sight of, certainly in the last decade!
The psychological phenomena of the "recency effect" and "availability heuristic" turns into a basic shifting of mental baselines. This phenomenon is explored in the ecological context at www.shiftingbaselines.org/index.php . Sorry to add more sad news into this already terrifying subject.
Megan - Capitalism has been hijacked for at least 40 years by political pressures. Essentially the game is called securitization... "I'd happilly pay you Thursday for a hamburger today"...
Make no mistake. Everyone in government, finance, insurance, and banking KNEW that the OTC derivative market was unregulated and out of control. It was the means to enable the sale of junk mortgage-backed securities to unsophisticated conservative investors. Everyone in the loop was getting greased... the mortgage broker, the originating bank, the mortgage securitizer, and the insurance (CDS) under-writer.
In the end, like all bubbles, only the principals at the top of the pyramid get out whole. They buy their protection via political patronage, and corporate law that isolates them from personal liability. The better tools to assess systemic risk were already there. Read Nouriel Rubini's blogs for proof.
Cazador -
Thanks for pointing out the huge difference in approach between the Bush and Clinton administrations. If there are people that can't make the cut-off for relatively high quality loans, there are two ways to change that - by helping those people qualify, or by simply lowering the standards.
Bush wanted to help those people through, for example, tax credits and explicit subsidies to help them come up with a down payment. Clinton followed the ACORN approach of simply forcing banks to lower their standards. It was the lower standards that got us into trouble.
Eric -
I agree with you that the Republicans deserve blame because they didn't try hard enough. Nevertheless, Republicans were trying to fix things and Democrats were doing everything they could to block stronger regulation of Fannie and Freddie. The people who tried, although not hard enough, to fix things don't deserve nearly as much blame as those who actively worked to prevent a solution.
Ann, you are exactly right - the Republican's greatest sin is not fighting the socialist schemes of Democrats hard enough. When the programs really start to fall apart, instead of saying, "I told you so. It's time to abolish the entire thing", moderate Republicans like President Bush feel trapped into trying to save socialist cancer before it spreads to the rest of the economy.
I am not a Republican, but if they are losing this debate, it is only because of their lack of understanding of free market economics and lack of commitment to cleaning up all the bankrupt programs, going back to FDR.
Well, the free markets are going to abolish Social Security, Medicare, FMAC, FNMA, Food Stamps and a lot of scams that rotten socialists sold to buy votes, and timid conservatives were afraid to reform or abolish these things when they had the opportunity.
Unfortunately, our democratic Republic is likely to be abolished in the process of revolt, but better good Americans on Main Street refusing to go along anymore, than the corrosion of seditious politicians.
Ann-
I was pointing out that promoting homeownership for people with low-income was not a Democratic belief but also an emphasis of a Republican president.
The problem with your comparison of approaches is that the lower banking standards is not what allowed people to buy a house without taking a personal financial stake in it and allowed the buyer to even borrow more than the price of the home! True, the lower standards under Clinton allowed for home buyers to have lower incomes and the default rate did rise some as a result; however, eliminating the down payment, on top of the already lower standards, exacerbated the situation.
Lee-
President Bush took the initiative (read my previous post that quotes his remarks to HUD in June 2002). He was far from "feel[ing] trapped into trying to save [a] socialist cancer."
There is plenty of blame to go around.
From 1992 to 2000, subprime mortgages increased from 2% of loans to 20% of loans.
That increase was the direct cause of the collapse of the market for mortgage-based derivatives which dried up all the cash in the system.
That increase in junk loans was the direct result of agressive promotion of them by the Clinton administration, including threats by Janet Reno and Jamie Gorelick to prosecute any lender who "discriminated" by asking for proof of income, employment or repayment history.
Yes, President Bush should have shut down the entire program, but of course the Democrats would not even allow any reforms. Bush and lots of people who knew the entire thing was a scam, hoped to bail it out slowly, turn it around and reform it. They were dreamers, and naive, but they were not dishonest swindlers like Pelosi, Frank, Schumer, Clyburn, Conyers, Harold Raines, Jamie Gorelick and the top brass at Lehman Bros and other defunct mortgage producers and packagers.
Today, on C-SPAN, the heads of these CRA programs were saying that the junk loans had to continue, in "order to create affordable housing". The banks can't afford this. The taxpayers can't afford this.
These people only care about their own pie jobs. The politicians only care about buying votes. The Harold Raines, Jamie Gorelicks, Rahm Emmanuels and others only care about cooking the books to maximize their bonuses.
As a note, some 18 years ago, I produced one of the first expert systems to drive a hedge fund for the back end of mortgage production. I resent the bad name given to honest bankers and securities traders by a few crooks who subverted the system through legislation, and now seek to cover it up with tons of deficit money.
You're right, Lee; the lions of Wall Street have no culpability. The decisions they made following the 2004 regulations to increase their leverage ratios upwards of 33-1 - much of it in the riskier mortgage-backed credit derivatives - had nothing to do with the crisis. Are these the honest bankers, who the SEC left to self-regulate, that you feel sorry for? Give me a break.
Lee-
Just to clarify, I didn't mean to imply you were absolving all of Wall Street, but the knowledge of what was happening extended well beyond those at the top.
Caz
Cazador, you do a poor job of constructing a straw man.
I have a pretty good idea of how various people at various levels contributed to this mortgage collateral crisis. None of the little players could have done it without the crooks in Congress subverting the Community Reinvestment Act to encourgage fraudulent loans to unqualified minority buyers. Congress did it to buy votes and line their campaign chests and pockets with cash.
The root cause is fraud. Remove the fraudulent representations, from the loan application, to the bond package profiles on the CDO insurance at AIG, and there would be no problems. Of course, there would be no loans to 5,000,000 illegal aliens, either.
Here's a rap song/video that was made describing the financial meltdown that's happening. It's pretty funny, and actually very informing too!
http://www.youtube.com/watch?v=LrBuPsvbHB8
I understand these effects on thought process but I am left with one frustrating question. You know those ads that you'd see on the right-hand side of CNN's or msnbc's website? You know, the one's with the dancing women and a bunch of big dollar numbers next to her? Who in their right mind saw that and said, "yeah, I want to own a part of that"? Granted I haven't been in the position of being a part of these loans on any side but are you really suggesting the people who are running the financial world from the top on down to the loan salesman are so disconnected from reality that they thought the dancing woman ad was for a good product? That just pisses me off and convinces me they should all be fired.