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Don't Blame Wall Street -- The Government Did It!

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*** Mod's note: Moved posts - sN ***

For the follow up posts on the Gold standard, and also some on fractional-reserve banking, please continue here.

I replied to the Island Scenario of fixed amount of gold in that older thread that you linked to. My reply is there.

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Unfortunately, this graph isn't adjusted for price-inflation or population growth

Nor is it given as a percentage of GDP... What it does show is that the increase in household debt accelerated most sharply in the lead up to 2003, when only Fannie and Freddie were securitizing mortgages. By the time big banks got into the action acceleration (not growth) had subsided and the trajectory began to curve down, until the bottom fell out.

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Can you provide a link that supports the statement that the banks were "forced"?

"caused by the government giving false promises of backing up mortgages " I understand this, and it obviously led to some bad business practices on the banks' parts. But as far as I can tell they did this willingly. As Yaron Brooks has said, if they make mistakes like that, they should simply fail.

However "government forcing banks to deal with uncreditworthy people" is something I haven't seen any evidence of. I've certainly heard the argument from many, like Limbaugh and others, but could you direct me to something that shows the banks were "forced", as opposed to just participating in actions that they shouldn't have, thus leading to consequences that should have caused them to fail?

I'm not denying that such evidence exists, I just would like to see it.

Smoking-Gun Document Ties Policy To Housing Crisis

And it's still alive today. Obama is building on the fair-lending infrastructure Clinton put in place.

As IBD first reported, Attorney General Eric Holder has launched a witch hunt vs. "racist" banks.

"It's a more aggressive fair-lending enforcement approach now," said Washington lawyer Andrew Sandler of Buckley Sandler LLP in a recent interview. "It is well beyond anything we saw during the Clinton administration."

The document: http://www.ots.treas...files/25022.pdf

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For anyone interested in actual facts, rather than right wing slogans:

http://rortybomb.wor...rding-the-gses/

This is the best summary of the whole issue I have seen so far.

If that's the best summary of the "whole issue", you obviously either do not understand what the whole issue is or you're simply spouting left-wing slogans. As long as you ignore the problems with FDIC/Fed regulated banks and the GSE, and ignore the fact that they had to be bailed out, you can continue to pretend that they were not part of the problem or were only led along by the sub-prime devils... poor innocent, ignorant big-banks/Freddie /Fannie!
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If that's the best summary of the "whole issue", you obviously either do not understand what the whole issue is or you're simply spouting left-wing slogans. As long as you ignore the problems with FDIC/Fed regulated banks and the GSE, and ignore the fact that they had to be bailed out, you can continue to pretend that they were not part of the problem or were only led along by the sub-prime devils... poor innocent, ignorant big-banks/Freddie /Fannie!

Sorry, what left wing slogans have I been spouting? I look at the data then I judge. Show me contrasting data and I'll change my mind. The data is overwhelmingly one sided in this case.

My favorite part of that link above is where the guy links to previous right wing analysis before the crash - http://www.cato.org/pubs/regulation/regv23n3/gunther.pdf - This one advocates the exact opposite position of the one it currently holds. This is proof that the organisation is either wilfully dishonest or unconsciously self deceiving, since they clearly will warp any data to fit their preconceived political views. An honest way would be to warp one's political views to fit the data.

I submit that most politicians know that CRA was a minor cause of the crisis, yet they will repeat slogans to the opposite effect in order to gain votes from people who haven't seen the data, or can't understand it.

Governments will try to do all sorts of odd things, and have the muscle to pull much of it off, for extended durations. People who do not get with the party-program are just as likely to be burned as people who buy it completely.

This quote from you I find interesting. You're essentially saying that European banks were forced into buying US subprime because if they didn't they would have lost money anyway? Have I got your argument right here?

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Sorry, what left wing slogans have I been spouting? I look at the data then I judge. Show me contrasting data and I'll change my mind. The data is overwhelmingly one sided in this case.

The data is overwhelmingly one-sided. The Case Shiller analysis shows that the bubble was well underway in 2003, when private firms started packaging mortgages. How do you blame high home prices on the private sector in 2003?

Once home prices were high and rising, and the conventional wisdom, from all sides, including especially Congress and the GSE's was that they would continue to rise unabated, we were in an unrecognized bubble dynamic. To take what happened after 2003 out of the context of what got us to 2003 is wholly irrational. To conclude that "from 2002-2005, [GSEs] saw a fairly precipitous drop in market share, going from about 50% to just under 30%" ignores the context of the market, in which they went from duopoly status in MBS to two of many competitors, and still they held onto 30% share. Are we to take away that GSE's were originating fewer mortgages? In 2002, they had 50% of a $700B industry. In 2005, they had 30% of a $1.2T industry. In other words, they were still running at full capacity right through the bubble.

Were the banks culpable in taking advantage of a scenario created by Congress and the GSE's? Absolutely! But this goes to the underlying issue of regulation v. policing in the banking industry. Once you start regulating an industries parameters, rather than policing fraudulent behavior, you create an environment in which honest businessmen leave for other industries, and frauds and cheats search for ways, within the gov't rules to make a buck. Alan Greenspan called this phenomena "The Attack on Integrity" in an essay in the early 1960's (in Capitalism, the Unknown Ideal). The banking crisis of the 2000's is proof positive that gov't regulation, as strict as it is in the banking industry, only served to breed dishonesty among bankers.

Edited by agrippa1
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Once home prices were high and rising, and the conventional wisdom, from all sides, including especially Congress and the GSE's was that they would continue to rise unabated, we were in an unrecognized bubble dynamic.

So you admit it was the banks fault in going along with the conventional wisdom? You concede that they were not forced to do this?

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My favorite part of that link above is where the guy links to previous right wing analysis before the crash ...
I did not read that Cato article, so I'll answer this generally...

Quite apart from the GOP, even true-blue advocates of free-markets often end up cheering the wrong concrete political compromise, even when they are correct in their principles. We live in a mixed-economy with all sorts of rules. When there is a concrete suggestion that some particular law be rolled back without rolling back some other law, the free-market advocate would say that all interference should be removed. Yet rolling back some one part might seem like a good way to make a half-step toward freedom, and they might cheer for it.

In any particular instance, this could well be a mistake, even a blunder. Nevertheless, it is not the free-marketers who are primarily to blame, but the folks (Democrat and Republican) who want to retain the countervailing laws that ought to have been repealed as well. It is not the free-marketers who brought us this hugely complex, unstable and redistributive mess of a system in the first place. They're not the ones to blame by saying: "See, you guys cheered this part of unravelling the system, without insisting on unraveling all of it." Instead, look to those whose philosophy kept those other laws in place. Don't blame the guys who wanted to remove all of the mess, but could not get their way; look to those whose philosophy made them insist on keeping some of the mess in place.

You're essentially saying that European banks were forced into buying US subprime because if they didn't they would have lost money anyway? Have I got your argument right here?
Are you aware of how banks that were very cautious pre-1913 were basically rendered unprofitable in the decades after the Fed was created?
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No, why were they rendered unprofitable?
For a bank, caution does not mean that it only has to be solvent. It also means that it has to be liquid enough to meet a run. A bank can be solvent and yet go under in a run. In a Fed-centric world, one has a lender of last resort with unlimited access to currency. The Fed does have rules, but if one sticks within those rules, they will not shut their discount window, and will be your lender of last resort. It does not make much sense to be more cautious than the rules allow, when it comes to considering whether one's assets can be discounted in an emergency. The decision is not: "Are these assets that a rational well-funded J.P.Morgan would be willing to discount against in an emergency?". Instead the question becomes, "are these assets that the Fed says they will discount against?"

As for the lender-of-last resort role that banks like Morgan used to play, nobody needs it any more. And, why would Morgan keep extra funds and come in to play vulture and to be a lender of last resort? The business model of the safest, lender-of-last-resort banks was rendered obsolete. In fact, much of the motivation behind creating the Fed was to render people like Morgan obsolete. After the panic of 1907, the pressure was on. It was a time of populism (Theodore Roosevelt was president during the 1907 panic), and the country switched to the system that has brought us where we are today.

it is unfair to name a single person as causing the current mess, but if one had to, Alan Greenspan would be the man. Of course, Theodore Roosevelt and his ilk should bear a part of the blame for getting the ball rolling, even though that's no excuse for their intellectual descendants, who kept the system alive.

If you have not read it, I strongly suggest "Money of the Mind" by James Grant. It is a history of U.S. loan/credit markets (up to the 1970s/1980s). Less easily available, is "Economics and the Public Welfare" by Benjamin Anderson. It is an economic-history of 1914 through 1946.

Edited by softwareNerd
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For those of you who still insist that no force was involved in the housing bubble / Financial Crises, keep in mind that every regulation and every fine imposed by the government is a gun aimed at someone's head. If the government told the banks that they can no longer redline segments of the population and told them they either could not expand or would be fined if they did not deal with the previously redlined segments, then you bet they were forcing the banks to deal with uncreditworthy people (by the bank's previous standards). Now, you might say this wasn't much, but every little bit adds to the pressure of doing business with uncreditworthy people, and so the banks followed suit and dealt with them, thinking, at least in part, that they could always dump the mortgages onto Freddy and Fanny -- which they did and F&F got bailed out multiple times as they took on these mortgages.

All of this lead to a speculative boom cycle whereby no one thought it could end because of the force to deal with ever-growing segments of the population. You might say no one forced the Wall Street guys into securitizing those mortgages, but given the circumstance, they too, thought it would never end. Now this was bad estimations on their part in the long run after the bubble burst, but it was force against the banks that started the whole mess. So, I still say Wall Street didn't do it, the government caused the speculation bubble, and are still adding to the fray by keeping interest rates below the rate of inflation and by continuing to force banks to deal with uncreditworthy people.

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All of this lead to a speculative boom cycle whereby no one thought it could end because of the force to deal with ever-growing segments of the population. You might say no one forced the Wall Street guys into securitizing those mortgages, but given the circumstance, they too, thought it would never end.

Or they, the smart ones at least, knew the nature of the setup, knew that the bubble would ultimately burst, and knew that if they did not take advantage of the situation as best they could, then others would. So they invest in and ride the bubble up in the hopes of selling out before it all comes crashing down. (Like anyone in a Ponzi scheme would.) In such a context, is it really anyone's fault for trying to do so? Play you lose; don't play you lose. Of course, given that the government gets a pass, those who succeed in playing the game as setup by the government end up becoming the whipping boys for the government when things go bad.

Edited by Trebor
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I understand. But the source of the problem, and why GS can be "smart", is government, even if GS supports what the government is doing. This is that problem of, if the government has the power to benefit companies of its choosing, companies will seek government benefits. What's needed is that wall of separation between government and the economy.

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The increase of the rate of money influx into a commodity or industry is the driver of an asset bubble. The inflation adjusted rate of growth of mortgage initiations (as inferred from adjusted rate of growth of Household Credit Market Debt) reached 5% (yr/yr) in 1998 and peaked at just under 10% in mid-2003, at the time private banks were just entering the MBS market. What happened after that point is simply the trajectory of an asset bubble as the flow of new money began to ebb, eventually reaching a net zero increase, at which point the bubble rapidly deflates. The flow of money into mortgages ended in early 2008, just prior to the financial collapse.

Once a bubble is created, the money-making pressure to get in while the bubble is hot is too great for most to ignore. If you don't make money off the boom, you are sure to lose as the gov't takes your assets to bail out those that were left holding the bag, or as the economy contracts in a deflationary deleveraging of the boom asset.

The stage for a full-blown bubble collapse had been fully set up by 2003, when Fan & Fred still enjoyed duopoly status. There are many ways to slice this issue - the only way to not implicate GSE's and Congress as the major causative culprits is to ignore everything that happened up to 2003. Every analysis I've seen that holds banks solely or majorly responsible has been based on history starting in 2003.

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So you admit it was the banks fault in going along with the conventional wisdom? You concede that they were not forced to do this?

I concede that the gov't created a banking industry that is limited not by morality, but by the regulations forced on them by the government. You treat people, even bankers, like animals, and you get animals. Surprise.

The only banks that were allowed by the gov't to package mortgages into MBS were those that had passed their CRA evaluation, as specified in Gramm-Leach-Bliley. So, yes, the banks were forced -- and incentivized -- to make subprime loans. The banks that did not participate faced lower profit margins and eventual loss of market share to those accepting the implied gov't subsidies. They had a choice, okay: Go along with GLB, originate sub-prime loans and sell them to Wall Street; or, close up shop.

Some banks refused to play along. The big ones were forced, yes forced, to take bailouts from the gov't. The small ones have paid the price in lost liquidity, lost business, more stringent regulation, etc. Their lesson, if they survive, is do what the gov't tells you, play along with Congressional schemes, get in line for the handouts, shut your f**king mouth and play ball, or get forced out of business.

Yeah, they made the "choice." I concede. What exactly is your point?

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For a bank, caution does not mean that it only has to be solvent. It also means that it has to be liquid enough to meet a run. A bank can be solvent and yet go under in a run. In a Fed-centric world, one has a lender of last resort with unlimited access to currency. The Fed does have rules, but if one sticks within those rules, they will not shut their discount window, and will be your lender of last resort. It does not make much sense to be more cautious than the rules allow, when it comes to considering whether one's assets can be discounted in an emergency. The decision is not: "Are these assets that a rational well-funded J.P.Morgan would be willing to discount against in an emergency?". Instead the question becomes, "are these assets that the Fed says they will discount against?"

This isn't being forced to lend. A bank makes more money in the long run (even with a lender of last resort helping its failing competitors) if it makes sound lending decisions.

For those of you who still insist that no force was involved in the housing bubble / Financial Crises, keep in mind that every regulation and every fine imposed by the government is a gun aimed at someone's head. If the government told the banks that they can no longer redline segments of the population and told them they either could not expand or would be fined if they did not deal with the previously redlined segments, then you bet they were forcing the banks to deal with uncreditworthy people (by the bank's previous standards). Now, you might say this wasn't much, but every little bit adds to the pressure of doing business with uncreditworthy people, and so the banks followed suit and dealt with them, thinking, at least in part, that they could always dump the mortgages onto Freddy and Fanny -- which they did and F&F got bailed out multiple times as they took on these mortgages.

The biggest originators of sub prime mortgages were not subject to CRA.

Or they, the smart ones at least, knew the nature of the setup, knew that the bubble would ultimately burst, and knew that if they did not take advantage of the situation as best they could, then others would. So they invest in and ride the bubble up in the hopes of selling out before it all comes crashing down. (Like anyone in a Ponzi scheme would.) In such a context, is it really anyone's fault for trying to do so? Play you lose; don't play you lose. Of course, given that the government gets a pass, those who succeed in playing the game as setup by the government end up becoming the whipping boys for the government when things go bad.

Goldman Sach's did more than just play the game. They committed fraud by creating a mortgage investment vehicle for one client who wanted to bet that it would fail, and then lied to other clients about this in order to get them to invest in it. Here there was no government involvement, just pure greed. Wall Street is to blame.

Besides, if your quote above is indeed the "game", then a firm who neglected to play would come out ahead in the long run. How can you argue that not investing in subprime during the boom was a bad strategy? Avoiding subprime would have been a great strategy.

The increase of the rate of money influx into a commodity or industry is the driver of an asset bubble. The inflation adjusted rate of growth of mortgage initiations (as inferred from adjusted rate of growth of Household Credit Market Debt) reached 5% (yr/yr) in 1998 and peaked at just under 10% in mid-2003, at the time private banks were just entering the MBS market. What happened after that point is simply the trajectory of an asset bubble as the flow of new money began to ebb, eventually reaching a net zero increase, at which point the bubble rapidly deflates. The flow of money into mortgages ended in early 2008, just prior to the financial collapse.

Once a bubble is created, the money-making pressure to get in while the bubble is hot is too great for most to ignore. If you don't make money off the boom, you are sure to lose as the gov't takes your assets to bail out those that were left holding the bag, or as the economy contracts in a deflationary deleveraging of the boom asset.

Here is the same argument as the commentors above. I fail to see why avoiding a speculative bubble is not a winning strategy for a company and its shareholders?

The only banks that were allowed by the gov't to package mortgages into MBS were those that had passed their CRA evaluation, as specified in Gramm-Leach-Bliley.

Can I see evidence of this please? As far as I know, GLB only restricts banks from merging with insurance companies if their CRA requirements aren't being met. There is no restriction on securitization in existing banks as far as I know.

Edited by IceFive
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@IceFive: Just in case you think I am arguing that banks (whether European or US) all acted rationally, then I'd like to clarify that I am not saying so. That is not the point. People act irrationally all the time, and very rich people and senior managers do so too.

The main problem is that the intellectual fore-fathers of "Occupy Wall St." are the ones who created this system in the first place: this system where the government becomes the lender of last resort, where risk-decisions have a political slant and where losses are socialized. And, the ideas pushed by the "Occupy Wall St." crowd can only take us in one of two directions: either it takes us to a high degree of risk-avoidance enacted by the government, and consequence slower wealth-creation; or, it takes us the a repeat of what we saw in the Great Depression and in the Great Recession.

In the marketplace, actors are often kept in check by other actors who have some skin in the game. Shareholders are only one such set to keep management in check. Government intervention has reduced the amount of policing by shareholders. However, for banks, depositors are a second check on the bank. Government intervention has made depositors care less whether a bank is sound. When Countrywide was in the news as going bankrupt, people were blase about buying their CDs at tiny premiums (0.5%-1%). Another check is bank bond-holders. In the recent failures, the government has pretty much insulated them as well. More and more, the government has taken away the dangers of bad behavior.

Of course, the government can clamp down and take the type of approach it does with the FDA, where it rather hold back good medication for years. it could do the same in the financial markets and retard growth. However, that's immoral, because it stops me from taking the risks that I want with my wealth. The government simply has to step out of the way, and let the risk falls where it may. People can choose to take risks or not, and can then choose to reap the benefits of suffer the consequences.

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Look, I am not saying that all of the mortgage players were forced into the sub-prime markets, indeed there were players who took the jump due to market conditions and the possibility of making money -- just as there is a market for "junk bonds" and Penny Stocks. However, it was the government who set up the parameters, especially by continuing to fund Freddy and Fanny when they would buy these mortgages and then almost go broke and then get bailed out. So, the government set up a market place that was not adjusted to the potential failures of dealing with uncreditworthy individuals -- and they set up these market conditions via force -- forced taxpayers to bail out F&F and forced other more normally sound banks to deal with uncreditworthy people. If the market had been free of government force and manipulation, then the cycle would have ended earlier, some banks would have gone out of business, and those dealing in sub-prime securities would have lost their shirts; thus everyone would have learned their lessons. However, with the government bailing them all out, it sets up further moral hazards of bad business practices that are not held in check by bad companies going out of business. In fact, TARP was done in such a way as to *shield* those who had bad business policies by forcing profitable banks to go along with accepting some of the bail-outs themselves. So, the mess has yet to be cleaned out at the taxpayers expense either by direct taxation or through the "easing" of money by the Federal Reserve (which causes inflation). In short, the bubble is still with us, and it is the force in the market place by the government that is preventing a nationwide correction of bad business policies.

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Wall St. is partly to blame. Like climate models, the popular financial models used for hedging risks are rationalistic constructs that must fail.
True, and -- behind them -- the blame lies with the rationalism that is taught in Finance course and MBAs across the country. Yet, when the "Occupy" folk decided to picket rich people's homes, they chose John Paulson as one of the targets, when he was someone who critiqued the models and bet against them in a very public way.
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Wall Street is not to blame for it effecting the entire economy, because that moral crises would not exist without the governmental interference. What would have happened if the government wasn't involved is that a crises would have come up sooner due to irrational policies of risk takers, and they would have gone out of business, leaving an otherwise healthy economy. But by the government being involved -- by force -- and creating the moral hazard in the first place -- by force -- and bailing out failures -- by force, they made the mess even bigger until it infected the entire economy. Rationalistic models do not work in reality because rationalistic models do not take the facts into account. However, had the same facts been present they would have failed at a much earlier rate without the bail-outs continually happening.

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