Political scientist Jeffrey Friedman has an excellent article arguing that political ignorance by both regulators and voters played a key role in causing the financial crisis:
You are familiar by now with the role of the Federal Reserve in stimulating the housing boom; the role of Fannie Mae and Freddie Mac in encouraging low-equity mortgages; and the role of the Community Reinvestment Act in mandating loans to “subprime” borrowers, meaning those who were poor credit risks. So you may think that the government caused the financial crisis. But you don’t know the half of it. And neither does the government….
Given the large number of contributory factors — the Fed’s low interest rates, the Community Reinvestment Act, Fannie and Freddie’s actions, Basel I, the Recourse Rule, and Basel II — it has been said that the financial crisis was a perfect storm of regulatory error. But the factors I have just named do not even begin to complete the list. First, Peter Wallison has noted the prevalence of “no-recourse” laws in many states, which relieved mortgagors of financial liability if they simply walked away from a house on which they defaulted. This reassured people in financial straits that they could take on a possibly unaffordable mortgage with virtually no risk. Second, Richard Rahn has pointed out that the tax code discourages partnerships in banking (and other industries). Partnerships encourage prudence because each partner has a lot at stake if the firm goes under. Rahn’s point has wider implications, for scholars such as Amar Bhidé and Jonathan Macey have underscored aspects of tax and securities law that encourage publicly held corporations such as commercial banks — as opposed to partnerships or other privately held companies — to encourage their employees to generate the short-term profits adored by equities investors…..
This litany is not exhaustive. It is meant only to convey the welter of regulations that have grown up across different parts of the economy in such immense profusion that nobody can possibly predict how they will interact with each other. We are, all of us, ignorant of the vast bulk of what the government is doing for us, and what those actions might be doing to us. That is the best explanation for how this perfect regulatory storm happened, and for why it might well happen again.
For more of Jeff’s analysis of the ways in which ignorance contributed to the crisis, see here, and his much longer academic article on the subject in a special symposium issue of Critical Review (which also includes important contributions by many other scholars).
I don’t know enough about financial regulation to have any strong opinion on whether Jeff’s arguments are correct (though many of them strike me as persuasive). However, his analysis does overlap with my own work suggesting that the size and complexity of modern government greatly exacerbates the dangers of political ignorance (e.g. here and here). It is definitely a good and thought-provoking piece, even if there are parts that are hard for me to judge.
CONFLICT OF INTEREST WATCH: Jeff was one of the people who played a key role in getting me interested in the issue of political ignorance back in the 1990s. As editor of Critical Review, he published my very first article on the subject back in 1998. So I owe Jeff a great debt for, among other things, pointing me towards a subject that is one of the main parts of my research agenda, and promoting my work at a time when I wasn’t well-known at all. At the same time, we have disagreed in print over several major issues relating to political ignorance. So I’m hardly an uncritical cheerleader for Jeff’s arguments, or he for mine. In this series of articles, I think he makes a valuable contribution to the debate, even if we ultimately conclude that some other explanation of the crisis is more compelling. My guess is that the ignorance Jeff points to was at least an important contributing factor, even if other causes also played a major role.
UPDATE: Jeff has another interesting article about the causes of the financial crisis here (coauthored with Wladimir Kraus).
HarryEagar says:
I’ll take this seriously when he explains how political ignorance forced Bear Stearns to leverage up 30:1 and similar follies.
February 9, 2010, 8:33 pmNelson Lund says:
Ilya–
I haven’t read the article to which you’ve linked, but maybe it would be useful for you to explain what you mean by “political ignorance by regulators.” I suppose that some kind of ignorance explains every mistake that everybody makes, as Socrates so famously argued. Unless one is careful, though, this kind of formulation can become one that explains everything in a way that really explains nothing.
February 9, 2010, 8:37 pmChristopher Hagar says:
In other words, even if top-down management of the economy were efficient despite the superiority of local price signals and diverse innovation, it would still fail in the disorder and irresponsibility of bureaucracy or government by committee.
February 9, 2010, 8:40 pmIlya Somin says:
I haven’t read the article to which you’ve linked, but maybe it would be useful for you to explain what you mean by “political ignorance by regulators.”
I mean ignorance of the way in which different parts of the vast welter of regulations overlap with each other and may have unplanned effects. Friedman’s articles give details on the specifics.
February 9, 2010, 8:47 pmIlya Somin says:
I’ll take this seriously when he explains how political ignorance forced Bear Stearns to leverage up 30:1 and similar follies.
If you read his articles, you will see that he does in fact cover this ground. In any event, Bear Stearns’ failings did not by themselves cause a massive systemic crisis.
February 9, 2010, 8:52 pmAllan Walstad says:
From Friedman’s article:
I’ve read this elsewhere too and it makes sense. Contrary to prevailing collectivist “wisdom,” economic instability is not generally the result of insufficient government meddling in the market, but rather the unintended effect of such meddling by economically ignorant and/or hubristic and/or opportunistic pols and other government officials.
February 9, 2010, 9:29 pmsecond history says:
California’s financial crisis will never be solved with the appalling political ignorance in the state:
February 9, 2010, 9:36 pmSammy Finkelman says:
Is this really *political* ignorance? Isn’t what you mean maybe “something that is similar in nature to political ignorance?”
That is, you have something with the same feature – that people don’t feel it worth their while to investigate something, and they rely on other people.
Two things that you seem to be alluding to are:
1) Ignorance of what the law is – like that in many states mortgagaes are non-recourse loans. Actually I think most people assumed that is what they were because in practice they don’t go after other assets unless the amount owed is over $100,000 and the person has assets.
2) Ignorance of how the ratings are done – or reliance on them.
I think what you are talking about is not “political ignorance” but its second cousin.
February 9, 2010, 9:54 pmRicardo says:
Friedman blames the ratings agencies for having been “shielded from competition” as this made them sloppy and more prone to overrate various securities. I’ve seen this argument before and it is underdeveloped and unconvincing.
In a business like rating, there are only ever going to be a handful of trusted players. Government regulations have very little to do with this. In the same way that Google has become the primary search engine (with Yahoo in a very distant second place), or that a handful of academic journals become the premier authoritative sources of original research in different disciplines, a handful of rating agencies are going to take the vast majority of the ratings market with or without government involvement.
Yes, the ratings agencies got sloppy. The point is that would have happened in any case. And supposedly rational firms were betting billions of dollars on rated securities that they were too lazy to do their own due diligence on. It wasn’t political ignorance: it was economic ignorance on the part of the princes of Wall Street.
There also appears to have been an ignorance on the part of CEOs and shareholders as to what exactly the traders at the investment banks were up to. Their activities simply don’t appear to have been on the radar screen for many people, including the senior managers at their respective firms. At AIG, it appears senior management paid very little attention to its credit default swaps business as long as it was generating steady cash flows.
February 9, 2010, 10:18 pmjimmy john says:
I don’t see the Rahn argument (tax law not permitting banks to be partnership resulting in diminished incentives). Why couldn’t the owners/shareholders personally guarantee the debts of the bank? (I’m assuming his argument is based on the possibility of the partner being liabile for the debts of the partnership.) Even if it were allowed, couldn’t the banks be set up as LLCs (can be taxed as partners, but with limited liability) or as a LP with the general partner a corporate entity (with limited assets).
Maybe there’s something else to his argument.
February 9, 2010, 10:19 pmNelson Lund says:
Everybody acts on the basis of incomplete knowledge all the time. If “political ignorance” just means an absence of omniscience, then I guess it probably does explain just about everything. I’m happy to assume, though, that the cited article provides enlightening specifics, whatever name one chooses to attach to the general phenomenon.
February 9, 2010, 10:19 pmIlya Somin says:
Everybody acts on the basis of incomplete knowledge all the time. If “political ignorance” just means an absence of omniscience, then I guess it probably does explain just about everything.
No, it goes well beyond mere absence of omniscience. Rather, the argument is that the system is so large and complex that it is often impossible to foresee even very important interactions between its parts.
February 9, 2010, 10:33 pmIlya Somin says:
Friedman blames the ratings agencies for having been “shielded from competition” as this made them sloppy and more prone to overrate various securities. I’ve seen this argument before and it is underdeveloped and unconvincing.
In a business like rating, there are only ever going to be a handful of trusted players. Government regulations have very little to do with this.Google has become the primary search engine (with Yahoo in a very distant second place), or that a handful of academic journals become the premier authoritative sources of original research in different disciplines, a handful of rating agencies are going to take the vast majority of the ratings market with or without government involvement.
This is not my field, so I don’t know if Jeff is right about this. However, “a handful” can still be a lot more than just three. In most academic fields, there are more than 2 or 3 major journals (in law there, are probably at least 20 or 30, in political science at least a dozen).
Even more to the point, in the absence of a government-protected oligopoly, it would have been easier for new entrants to compete in this market and point out the flaws of the big three. Yes, google is the dominant search engine (now). But there are many alternatives, and they can easily displace Google if it becomes inferior, as Google itself easily displaced altavista and others.
February 9, 2010, 10:38 pmAllan Walstad says:
Exactly. Protected from competition, where’s the danger in sloppiness? But it may go farther than that. Downrating securities would have spoiled the party for the pols–the ones protecting you from competition. And if the banks were betting that the pols would step in and bail them out, well guess what–most of them did get bailed out at our expense.
February 9, 2010, 10:55 pmRicardo says:
This leaves the question unanswered of why Lehman Brothers, Bear Stearns, and AIG did not themselves point out the flaws of the big three. They were the ones with real money at stake: if anyone should have recognized that the subprime-backed securities did not deserve AAA ratings, it should have been them. Nobody ever twisted the arms of the major investment banks forcing them to invest in these securities (no, they are not covered under the CRA so no dice there). They could have easily disregarded the ratings while investing on their own account, just as many informed investors already discount or ignore altogether recommendations from “experts” on stock picks. Indeed, Goldman Sachs shorted the market in the months before the crisis.
We are not left with a good explanation of why almost all of the major market players catastrophically failed to take notice of the risk associated with AAA-rated subprime securities. Government regulations only make ratings by the non-big-three less valuable, they don’t prohibit them altogether. Again, with billions of dollars at stake it is not enough to just blame the government here. The firms themselves were being irrationally ignorant about just where their money was going.
February 9, 2010, 11:01 pmRicardo says:
The danger in sloppiness is in being ignored and losing one’s reputation. Even if Jim Cramer or Larry Kudlow had a government-protected duopoly on predicting the market, I would still ignore them and I think a lot of others would as well.
I don’t see the connection. Ratings agencies make money by being paid to rate securities by issuers. They have a much bigger incentive to not ruin their relationships with investment banks who were channeling tons of business their way. The government never forced investment banks and ratings agencies to do things this way: it was the best way the market could come up with for paying ratings agencies for the public good they provide. I’m not sure where the “pols” come in.
February 9, 2010, 11:11 pmrpt says:
There is a theme of “it’s all government’s fault” in many comments here. Does libertarianism mean that private actors are never wrong, should never be held to account for their actions, and always think with their brains, rather than with other organs of lust?
Speaking of political ignorance, the $-bagger convention featured both birthers (Farah) and 9-11 truthers (Tancredo).
February 9, 2010, 11:19 pmCaptain Ned says:
February 9, 2010, 11:52 pmCaptain Ned says:
State-level financial regulator here; we do all our bank work to FDIC spec because that’s what they demand to consider our state-only exams as meeting FDIC guidelines for examination frequency.
A direct quote from the FDIC Risk Management Manual of Examination Policies (Section 3-3, Securities and Derivatives):
Our marching orders told us to take these ratings as gospel.
FDIC Manual found here: http://www.fdic.gov/regulations/safety/manual/
February 10, 2010, 12:03 amDuffy Pratt says:
Suppose that adopting a smaller and more understandable regulatory scheme had unexpected effects that were undesirable?
February 10, 2010, 12:27 amRicardo says:
I know. My point is that even without any regulations, you are still going to have only a few agencies that are routinely trusted. The value of ratings is that they allow you to draw a couple of securities from a market and compare them all. You can only do that if the probability is very high that for a pool of securities, they all share a rating by at least one company. This inevitably results in a few players dominating the market. You see this same kind of natural concentration in things like search engines, restaurant guides, and even blogs. It’s a winner-take-all market out there.
Moreover, to blame regulation, you have to propose an alternative set of regulations that would not led to similar problems. Would your job be easier or harder if you could rely on any one of hundreds of ratings agencies out there when evaluating a bank’s capital adequacy and risk exposure? If Billy Joe Bob’s rating agency says a certain debt security is AAA, do you go ahead and treat it as AAA? Or do you have some separate government-run certification process to first certify Billy Joe Bob as a competent rating agency? Or do you do exactly what you do now and just rely on the top rating agencies in the market? Or does your agency simply take over the job of rating securities itself?
February 10, 2010, 12:31 amHarry Eagar says:
I ain’t buying. I’ve been a business reporter for four decades and through about five up and down cycles. Bear Stearns is only a good poster boy because it got caught out first.
Nobody in his right mind leverages 30:1 and stays leveraged. Maybe a real gambler would do it for a short season, thinking, maybe, that he had some guarded information that gave him an edge.
But if you plan to leverage and stay leveraged — and that’s exactly what was going on at Bear and many other important players — then the crash is certain and the only uncertainties are when it happens and what event will start the scramble.
And what induced money handlers to leverage that much? Hot money.
Once you gear the system to hot money, somebody will always overbid for deposits, and — if profits are the only gauge of financial efficiency — everybody else will be dragged up and tramped under. The market cannot not crash.
The causes are not in the entrails of regulations.
February 10, 2010, 12:31 amAlan K. Henderson says:
One thing I’ve never understood: a lot of politicians, finance gurus, etc. saw no inherent problem in the idea of home values rising faster than incomes.
A house is a unique kind of investment. You buy it because today’s mortgage rates will eventually cost less than the alternative of renting, and because it will eventually be paid off. Barring physical improvements to the house, you don’t want its price rising dramatically faster than incomes if you intend on selling it. You want people to be able to afford it.
I’ve seen home values quadruple over the past 35 years. The job that paid 30K in 1975 is not paying 120K today, and minimum wage ain’t twelve bucks an hour. Were they betting that the rise in two-income families would keep this bubble alive? What were Alan Greenspan and ACORN and the Senate Banking Committee and all these other involved parties thinking?
Housing hyperinflation’s chickens are coming
February 10, 2010, 12:46 amto a cheap trailer parkhome to roost.Christopher Hagar says:
Act according to principles, not for effects. This duty is especially clear when devising laws which have complex interactions with thousands of other laws, millions of people, and in billions of acres.
You do not even think of trying to calibrate potential and unforeseen effects of a law against murder, as the justice of the underlying principle is inculcated from birth.
Compare deontological ethics, and note the utilitarian purpose of the social-welfare state.
February 10, 2010, 2:21 amDid Political Ignorance Help Cause the Financial Crisis? | Liberal Whoppers says:
[...] the original here: Did Political Ignorance Help Cause the Financial Crisis? [...]
February 10, 2010, 2:36 amArkady says:
Is there any reason to believe given a streamlined regulatory regime (whatever that means), that on the business side, the system would still be so large and complex, that it would be impossible to to foresee, etc.? Given the creativity displayed in the creation of financial instruments, I’m not at all sure. See, Financial Innovation Watch. See, also, Recipe for Disaster: The Formula That Killed Wall Street. And, Wall Street Pursues Profit in Bundles of Life Insurance.
February 10, 2010, 6:11 amNelson Lund says:
Using the term “political ignorance” to describe an (alleged) “impossibil[ity] to foresee even very important interactions between [a system's] parts” is strange at best.
February 10, 2010, 9:05 amArkady says:
In the above:
Is there any reason to not believe …
February 10, 2010, 9:10 amscattergood says:
This whole line of arguement is basically resting on the notion that the fiscal crisis was unexpected. It wasn’t. Period, end stop.
There were a number of economists (Robini, Keen) and traders (too many to name) who predicted fiscal calamity. Some were laughed at, but the traders that stuck it out made a ton of money for betting their opinion.
The majority of people in politics, economics, the markets, and the public had adopted a number of bad, really bad, ideas: markets always go up in the long run, more regulation reduces risk, the FED controls the interest rates of the USA, there is no default risk for GSE’s, etc.
These ideas lead people to make bad, really bad investment decisions. That they were bad investment decisions were seen by many people, and thus the crisis wasn’t unexpected by some.
This statement is basically just false. Nearly all the hedge funds stayed out of the MBS market. I believe Bill Gross at Pimco extremely limited his exposure.
Fannie on the other hand WENT AFTER subprime loans in 2004-6 in a hard way. They saw it as a GOOD thing. Oooops.
The point is the market is a battle of good and bad ideas, with score being kept every day. The things regulations do to make it not a fair battle of those ideas exacerbates the problems.
February 10, 2010, 9:26 amrj says:
Just because people don’t accept your premise doesn’t mean they’re ignorant.
February 10, 2010, 10:26 amRicardo says:
No, it is not “basically just false.” Any given hedge fund is tiny compared to the biggest investment banks, which are included among “major market players.” I worked for a mid-sized, buy-side investment manager and our AUM was bigger than the vast majority of hedge funds. The sell-side investment banks are absolute behemoths by comparison. And almost every single one of them except for Goldman Sachs had catastrophic levels of exposure to subprime.
In any event, I’m not sure what you are basing your statement about nearly all hedge funds on. It’s not as if they share their holdings and exposures with the public. Do you have access to some data that the rest of us do not?
February 10, 2010, 10:29 ambyomtov says:
Too much regulation caused the crisis? Less would have been better? Wow. That’s not what I thought.
Maybe we could ask someone who knows quite a lot about regulating financial institutions, and hardly has a pro-regulation bias:
Tell us, Mr. Greenspan should we have looked more to market self-regulation?
“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform…
…I’ve found a flaw [in my ideology]. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”
Also,
“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower,”
CRA, my left foot. Anyone who is still trying to flog that as a significant source of the problem, as Friedman apparently is, is trying to sell you a bill of goods.
February 10, 2010, 11:23 amJohnny Longtorso says:
Here’s a short article on how Fannie/Freddie/CRA changes in 2005 caused the crash. The CRA changed in 2005 to concentrate on large bank lending, and large banks had worse performance under the CRA than small banks. Fannie and Freddie were also ramping up the lending in the wake of their earlier accounting scandals. Put the two together at the same time and you have a housing bust.
February 10, 2010, 11:29 ambyomtov says:
Johnny Longtorso,
I think you should read the MN Fed article your anonymous blogger references. You might also take a look at the Fed study (from 2000) that is cited. It’s not very powerful support.
February 10, 2010, 12:41 pmAllan Walstad says:
Are you actually suggesting that being in an SEC-created cartel protected from competition by regulatory barriers has no negative effect on performance?
As Thomas E. Woods suggests in his book Meltdown, “…the [ratings] agencies knew which way the wind was blowing, with every federal agency having even the slightest connection to housing pushing various home ownership initiatives that involved lowering standards.” You have truly destructive pols like Barney Frank saying oh no, there’s no problem with Fannie and Freddie, no housing bubble, nothing to worry about, even as the Bush administration, for all its faults, was trying to rein them in. What should be well-understood by now is the role of the Federal Reserve (a government-created banking cartel) in creating bubbles and busts by jerking around with the money supply. Why is this permitted? Because it enables the pols to spend money they don’t have–it’s one of their addictive pick-me-ups.
Where do the pols come in? They are in it through and through.
February 10, 2010, 12:49 pmJohnny Longtorso says:
I have read the MN Fed study. I fail to see your unspecified evidence the post I linked to is wrong. The MN Fed had some “poor people covered by the CRA aren’t all that much worse credit risks than these other, slightly less poor people” stats, but that doesn’t prove much. Either the CRA caused a lot of loans, which reinforces claims it caused problems, or it didn’t. If it didn’t, what exactly was its purpose? I see a bunch of defenses of govt affordable housing initiatives saying basically that they were too small to do any harm. That would also have made them too small to do any good, thus negating all the praise those initiatives received from the left, pre-crash.
The Fed study in the article I linked to gives real live CRA profitability stats from surveys of lenders. What exactly is wrong with that, other than not being politically useful?
February 10, 2010, 12:55 pmscattergood says:
So banks are the ONLY major players? OK if you define it that way I guess you are right.
If you define major players as banks, then yes most banks were involved in MBS and the debacle there. However Freddie and Fanny were the largest purchasers and resellers of MBS instruments, and were the most highly regulated and intertwined with the gov’t.
But you miss the bigger point. MANY people saw the financial crisis coming. Some were in hedge funds, some were in large bond funds, some were in academia, etc. but they were basically ignored.
Keen at debtdeflation.com has the it right in my mind. The Austrians have it basically right in my mind. Massive debt, spurred by gov’t meddling with policy and regulations, reached unsupportable levels and is being deflated. There is a ton of pain in that process, but it will happen.
The four worst and scariest words in investing and economics are: “It’s different this time”.
February 10, 2010, 1:23 pmChristopher Cooke says:
The gist of the article is that certain rules regarding capital were changed and the change had the net effect of encouraging banks to load up on AAA rated mortgage-backed securities. That may be true, so far as it goes, but it does not explain the catastrophic failure of banks and investment banks, on a systemic-wide basis, to predict and manage their own risk.
The SEC let the large investment banks reduce their net capital requirements precisely because they supposedly had this great ability to model risk. The investment banks were wrong and the SEC was wrong. That is a failure of the private sector and it is unrelated to the ratings firms (which share some blame), or the regulators (ditto). That is what Greenspan is referring to in his earlier remarks, quoted above.
February 10, 2010, 1:40 pmHyman Ciotta says:
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February 10, 2010, 2:03 pmJeneva Longwell says:
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February 10, 2010, 2:07 pmChristy Clinton says:
Libertarianism doesn’t posit that private individuals are never wrong. Quite the opposite. It posits that all individuals will inevitably be wrong at least sometimes, and therefore it is to the advantage of all not to institutionalize these errors with force of law, thereby reducing the liklihood of a systemic meltdown.
February 10, 2010, 2:56 pmbyomtov says:
Johnny longtorso,
I see a bunch of defenses of govt affordable housing initiatives saying basically that they were too small to do any harm. That would also have made them too small to do any good, thus negating all the praise those initiatives received from the left, pre-crash.
This hardly follows. A program can do a great deal of good for a segment of the population without being big enough for its problems to affect the entire financial system.
The Fed study in the article I linked to gives real live CRA profitability stats from surveys of lenders. What exactly is wrong with that, other than not being politically useful?
First, it’s a survey that only 143 out of 500 institutions (representing about half of CRA loans) responded to. We don’t know what sort of self-selection may have occurred.
Second, by the authors’ own admission, the quantitative content is limited.
“The number of responses based on actual tabulations for quantitative profitability measures is quite small. For example, fewer than 5 of the survey’s 143 respondents provided quantitative responses based on actual tabulations for the profitability of CRA-related lending for any loan product.”
Third, it was explicitly based on 1999 data and published in 2000, well before the crisis, so whatever the facts were then they were quite possibly different 5-7 years later.
Finally, the results are far from definitive. CRA loans may have been slightly less profitable (in 1999) than other loans, but that hardly puts them at the center of the crisis.
February 10, 2010, 3:05 pmJohnny Longtorso says:
Estimates run from $4.5 trillion to $6 trillion in CRA loans. If the segment helped is large enough to be significant, the program is large enough to do harm. Giving me $10 million just for my own personal wonderfulness helps a small segment of the population (me and my immediate family), but obviously wouldn’t impact the entire country. Your claim really doesn’t add much to the discussion.
Ah, the well performing, profitable half just chose not to respond just to slander an innocent government program. Gotcha.
That’s not “well before” the crisis, and you give nothing to give us any reason to expect big changes other than an assertion that it isn’t physically impossible for it to change.
February 10, 2010, 3:17 pmJohnny Longtorso says:
FYI, the Bank of America 2008 stat (CRA loans being 7% of their residential book, but almost 30% of their losses) certainly isn’t “well before” anything, and backs up the 1999/2000 survey information in my link above.
February 10, 2010, 3:37 pmbyomtov says:
Estimates run from $4.5 trillion to $6 trillion in CRA loans.
Check again. In 2007 the entire mortgage market was $10 trillion. Do you really think CRA mortgages were around half?
Giving me $10 million just for my own personal wonderfulness helps a small segment of the population (me and my immediate family), but obviously wouldn’t impact the entire country. Your claim really doesn’t add much to the discussion.
It adds as much as your original claim did. You said if CRA mortgages weren’t big enough to affect the financial system they couldn’t have done much good. As you’ve illustrated, that’s just not so.
the well performing, profitable half just chose not to respond just to slander an innocent government program. Gotcha.
I didn’t say that. I said that there may have been some self-selection. I didn’t say why, or what the motive was. My point was just that it’s worth considering when evaluating the results.
That’s not “well before” the crisis, and you give nothing to give us any reason to expect big changes other than an assertion that it isn’t physically impossible for it to change.
It’s 5-7 years before. Do you think everything just stayed the same? And it wouldn’t have taken big changes. The survey reported fairly small differences in performance.
I notice you have no response to the fact that the survey was very light on actual quantitative data, as the authors repeatedly mention, and that such differences as they do report are, as I said, small. That caused the meltdown, and not the behavior of the financial markets? Be serious.
February 10, 2010, 4:49 pmHarryEagar says:
‘I’ve seen home values quadruple over the past 35 years.’
In Honolulu, for example, from 1955 to 2005, home prices went up 1000% — $50K to $500K. That’s about passbook savings rate.
50 years is a long time at compound interest.
Johnny’s claim that CRA loans totaled $5T seems improbable, as that would make them about one-third of all mortgage loans.
Greenspan, in his autobiography, said he thought government could not oversee credit markets but did not need to, thanks to private counterparty surveillance.
Hmmm. There wasn’t much of that being done, but I don’t think you can blame Barney Frank. People thought they couldn’t lose. They were wrong.
There were financial panics before the New Deal legislation, notably Glass-Steagall, and after G-S was repealed (on Phil Gramm’s promise we would all soon be rich), but not in between.
A powerful argument for going back to New Deal oversight.
February 10, 2010, 4:54 pmCB says:
Deposit insurance the cause of risk-taking by banks? How about deposit insurance being used to entice people to actually deposit their money in banks after the people realize the bankers are actually gambling with their hard-earned money? The bankers had/have broken the public trust. Same reason they had to extend deposit insurance to money-market funds during the recent crash. People would have withdrawn their money from their 401ks because they realized the spectacular risk-taking going on in the financial system and were at high risk of losing their uninsured money-market funds.
I have a retirement account that only allows stock, bond or money market investments. I left my money in the account during the crash because of the insurance that was temporarily applied to it. However, I consider daily accepting the 10% penalty to take my money out of that account to deposit it in an account that does provide deposit insurance because I realize the high risk and danger of the financial system the way it is currently structured. And if the banking system didn’t provide insurance, I’d find a safe place for it outside of the banking system.
You don’t have to be omniscient or a master of the universe to understand that mortages with no money down and a second mortage on top of that is extremely likely to create problems in an economic downturn. Or the awarding of adjustable rate mortages given to any clown without documentation out there or Alt-A or option ARMs which were not just for subprime borrowers. These masters of the universe certainly know about the recurrent business cycles. I suspect they chose to look the other way because they were now able to bundle the mortages into securities and sell them off to the sheeple all over the world. Not their problem anymore, or so they thought.
And let’s not forget the Federal Reserve is chartered to protect the banking system, not the consumers, which is what Greenspan did…very poorly.
February 10, 2010, 5:12 pmJohnny Longtorso says:
Big enough to do any overall good for “the poor” is big enough to do damage, as is evidenced by every pre-crash claim of all the good it did. My point is that the left wouldn’t have been writing articles praising a program that gave me, and me alone, a wad of cash.
$4.5-6 trillion over a span of a few years leading up to 2008 vs. a single year’s number? Why is it unbelievable, other than it not allowing you to claim the CRA was too small to be significant one way or another?
And I noticed you said nothing about BoA’s 30% share of losses, which backs up the claims of the 2000 survey. Is straight from the horse’s mouth not good enough for you? The behavior of the financial markets was determined by government action, not government inaction. It isn’t a case of a law vs. “the behavior of the financial markets” if the former determines the latter.
The survey shows a consistent pattern, and is backed up by claims made elsewhere about large banks needing to make the loans to allow mergers, etc (which would imply that the rules impacted larger vs. smaller institutions differently, which makes it not a surprise that they’d perform differently). If you want to assert the survey could be better, I agree. I wonder why the government isn’t asking banks for that sort of information? Never mind, I’m not wondering. Its pure CYA.
I noticed you ignored Wallison’s calculation that 2/3 of the questionable loans were made under the influence of government.
PS. Ever plan to address the Fannie/Freddie side of the argument in the post I linked to?
February 10, 2010, 5:29 pmRicardo says:
I think that’s about right. You also have AIG which was not really an investment bank but was the largest single seller of CDSs on the market and made the fatal decision to start holding the other end of the swap itself rather than reselling it. The point is that these are the largest firms, the ones most involved in subprime related securities, and the ones most likely to cause contagion and contribute to systemic risk.
As for Freddie and Fannie, they became heavily involved in subprime-backed securities only in 2006 by following the lead of Lehman Brothers, Bear Stearns and others. As I recall, even in 2006 the majority of subprime securities were still winding up in private hands. So being the “biggest” (which was only true at the very peak of the bubble in 2006) still does not mean controlling the market.
Moreover, I don’t miss any point about some people having seen the crash coming. I never said otherwise. What I said is that those with the most skin in the game (the aforementioned investment banks with billions of dollars of exposure) through a mix of arrogance and ignorance let themselves realize catastrophic losses as their actions led to a full-scale financial crisis. The main source of ignorance in this game was not political. The fact that some hedge funds (I don’t believe it is nearly all, as you claimed) made piles of money by betting on the crisis is neither here nor there. Hedge funds collapse every day and nobody takes any notice. When an institution like Lehman Brothers collapses, it sends ripples throughout the entire financial world.
February 10, 2010, 8:59 pmRicardo says:
Johnny Longtorso,
Fed Governor Randall S. Kroszner
Moreover, BoA’s CRA-related losses really don’t have anything to do with the broader financial crisis as BoA was actually in pretty good shape until Hank Paulson forced them into the shotgun marriage merger with Merrill Lynch. It was only when they took on Merrill Lynch’s subprime exposure (the full extent of which was not known to BoA when it sealed the deal) that it got in trouble. Merrill Lynch was yet another investment bank not at all covered by the CRA that wound up with huge exposure to subprime risk.
February 10, 2010, 9:13 pmJohnny Longtorso says:
My link explicitly addressed that. BoA said the 7% of their portfolio stemming from the CRA was 30% of their losses. You can’t just assert the CRA had nothing to do w/ those losses when the bank in question said they did. Even if your 6% is true, BoA shows it can do damage.
Talk about “loans sold” ignores the fact that banks would rather have covered their CRA requirements with AAA tranches of CRA mortgage securities than buy the individual loans directly from non-CRA lenders.
February 11, 2010, 9:13 am