There was actually a host of things that went wrong, but the regulations got the banks to lower their standards in order to get more people into houses (a national goal of most administrations over the past 20-30 years). And one reason banks lowered their standards was the thought of being bailed out, as they did for the Savings and Loan Crises and other times, so yes, in some limited sense the banks were at fault for counting on a bail out. However, if one realizes that the regulations came about due to not enough people being in houses (according to the government), then one can see that they regulated down the standards.
Regarding credit default swaps and other financial instruments based upon mortgages. I would say, yes, there was some fault there for thinking the bubble would never burst due to them also thinking everyone was going to be bailed out if things went wrong. If it wasn’t for the regulations, they would not have taken such risks and kept buying into mortgage backed securities. But the government was forcing there to be a larger market than there otherwise would be and it seemed like nothing could go wrong so long as Freddie and Fannie were buying up mortgages and being bailed out by the government (which happened several times before the crises).
In short, had the government stayed out of it, the great risks would not have been taken aside from a few risk takers and when it collapsed, it wouldn’t have spread to the whole economy. The forced bail outs are part of my calculations, hitting the taxpayer with $700 billion more in debt. A free market is the only solution to the problem. If people want to take extraordinary risks, they are free to do so, but the government cannot back them up and they cannot take others down with them.
And the reason it did that? Because it is a thorough argument. Understand though, that his argument doesn’t just lump all the blame on the CRA. Frankly that should be immediately recognized as a specious argument in such a complex system.
Same thing with the F&F arguments, something that have been a bit of a sticky wicket for me. I never actually found any reliable/sourced documents out there that show that F&F securitized subprime loans. From what I understand, they bought subprime securities, but they didn’t actually securitize/underwrite any of them.
One of the sticking points on that is that people treat Alt-A loans as subprime, which I’m not sure is a fair definition. F&F definitely did do a fair amount of business in Alt-A mortgages.
I think a lot of it had to do with the ratings agencies being completely off their meds and the europeans getting caught up in the same speculation fevor everyone else was.
Yes, I was thinking about Carter enacting the CRA, but Clinton giving it teeth (heavy fines for non-compliance).
I don’t know about fines, what they did was deny regulatory approval for interstate mergers unless you were CRA friendly. In Sowell’s book there’s a chilling quote from Janet Reno about it.
I think European banks bought up the securitized mortgages for the same reason everyone else did – they were all under the impression that the US Government was going to back up the mortgages, as they stated a few times during the boom. In other words, everyone was treating them like some sort of government backed securities – like government bonds – and so they thought it was a safe bet. Part of the reason they came to believe this was that as Freddy and Fannie bought up the mortgages and they went toxic, the US government did bail them out, several times before the big crash. And government officials were saying and implying that they would continue to do that; hence everyone began to think it was a safe bet.
Someone earlier had asked me why I thought it was evil to impose a standard onto someone, and especially evil to impose a standard onto businesses. The human mind requires freedom in order to function properly – that is, rationality requires the operation of free will focused on the facts of reality as the sole criteria. Once one introduces force – the initiation of force – the human mind tends to shut down or will no longer focus on anything aside from the gun pointed at his head. This is evil. It is especially evil to do that to those who are willfully providing a service or a product in the market place. The operation of capitalism and the benefits thereof require freedom, not force. As force negates the human mind, so it negates the products of the human mind – those goods and services that would otherwise have been produced.
I don’t know about fines, what they did was deny regulatory approval for interstate mergers unless you were CRA friendly.
Exactly, and there too you will probably not find any objective rule that says “we won’t let you merge unless you have 5% of crap on your books”. The beauty of our current system is that the rules are subjective. People speak of the President’s so-called “bully pulpit”; but regulators at all levels have similar “bully pulpits”. The priest in the bully-pulpits do have a gun under their vestments. The blackmail is very gentlemanly. I have personal experience with one credit card company that had internal quotas for accounts they should open for certain “segments” of the population that would not be targets of their usually algorithms.
Exactly. Contrary to the title of this thread, it was the bankers own fault.
No, that does not follow. Governmental action is a major source of risk. People have to act with their best guesses of such action.
In the same way, pensioners who put money in fixed-rate deposits were taking on interest-rate risks. Now that the government is keeping rates low, it does not follow that it is the pensioners’ own fault.
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.
I think it’s fair to say that it was a little from column A and a little from column B.
The CRA/FDIC thing pulled a number of banks to make riskier loans. Then you started seeing some hints that banks, even non-CRA banks, were under threat of being held to “higher standards” for low income loans etc. The 90s was a really bad time for this. This was a push. With the hole market moving towards these riskier portfolios, particularly during a speculation boom, it was hard for a bank to get the kind of profits that were “the norm” without taking on risk.
So, they made the choice to push towards riskier financing, but the housing boom, the shift from the internet speculation, the glass-steagal deregulation, etc etc, made for the perfect cattle run to encourage them to lead themselves into the slaughter house.
Long story short, this is why I use credit unions. Why would anyone put their safe/savings/low risk money into an institution that they have no control of?
Long story short, this is why I use credit unions. Why would anyone put their safe/savings/low risk money into an institution that they have no control of?
In FDIC-backed banks customers are covered by the government up to a certain amount (I think it used to be $100,000, but it is $250,000 now). Up to that number, keeping money in an FDIC bank is has no more risk than keeping it in a credit-union.
I agree that the govt is ultimately to blame almost 100%. Every bubble, depression and severe recession is always WITHOUT EXCEPTION due to govt interference in the economy at some level, which is why I agree with Ayn Rand that there should be separation of State and Economy.
The specifics are varied and complex but there are some basics which in my view account for the bulk:
Cheap credit from Chinese money courted by govt
Artificially low Fed interest rates (in 2000 Greenspan reduced to 1%, less than inflation and Ron Paul predicted the very following year that the bubble would collapse in due course)
Monetary mischief from the Fed by printing money due to lack of a gold standard. The Fed should be abolished as Paul says.
Govt-driven home ownership promotions
As stated by others, govt backing of mortgages and legislation that fosters lower lending standards
One curious fact that the official report on the causes of the 2008 crisis reported was that mortgages that resulted from the CRA accounted for only about 6%. A friend and I argued this point. He said that the laxity that followed from the lowering of standards on the 6% ultimately affected the 94%.
One curious fact that the official report on the causes of the 2008 crisis reported was that mortgages that resulted from the CRA accounted for only about 6%. A friend and I argued this point. He said that the laxity that followed from the lowering of standards on the 6% ultimately affected the 94%.
I’d say that the major source of causation flowed from regular and prime mortgages toward the sub-prime ones: via the effect on home-prices. When credit booms and flows to an asset-category, the price of those asset goes up. Typically, lower quality assets in that category go up in price as well (“rising tides lift all boats”). Thinking that prices of homes would rise was the single biggest factor inducing loans (including sub-prime loans) and all the more complex financial assets based on those loans.
The notorious Greenspan put and Bernanke’s “helicopter drop” reiteration of the put led people to assume that the Fed would try its best to ensure a floor under nominal prices of assets. This turned out to be a valid assumption. However, even the Fed can only do so much. The question then becomes: what type of floor can the government actually support. People who completely buy the government’s party-time theme (“use your home as an ATM”) are irrational. However, people who don’t get with the program and who assume that the government will simply sit by and do nothing, or who act as if we’re in a free-market are irrational in their own way. Government involvement in the economy is so high, that guessing correctly about government action is a major criterion for success. (Witness the recent upheavals in the stock market driven by ever changing guesses about what European governments will do about the debts of their “PIGS”).
In a free-market, actors who are using other people’s money are kept in check by those other people. However, when those other people are being back-stopped by government guarantees, this removes the most important check that a free-market would impose. When the recent crisis was clearly upon us, and Countrywide was clearly in trouble but not yet dissolved, they (Countrywide) tried to raise funds by offering CDs with slightly higher rates. In a free market, they would have had to offer a huge premium to induce people to invest. However, with the FDIC guarantee, putting money into their CDs carried only a small risk of inconvenience and slight delay in return of principal. A small premium of about 0.5% was enough to induce people to buy their CDs. If bad actors are not checked by funds drying up in such bad times how can one expect any checks during good times? [The same principle plays out with food and drugs: with the government being the rule-setter and proactive policeman in those areas, it drives out private-sector options, since people don’t see the point.]
Of course if the FDIC and the Fed were to tighten standards, if Glass Steagall were to be brought back, and so on we would reduce risk-taking. We could go all the way and reduce fluctuations to North Korean levels: stagnation and steady decline are the ultimate non-fluctuation.
To understand this you have to look at it as a dynamic progression, with each player having a role to play in the development…
Yes, CRA played a role in undermining the integrity of gov’t-subsidized banks and investment houses. Banks had to meet CRA standards to combine with investment co’s and create MBS’s. GLBA was passed in 1999, allowing this, but the first banks didn’t securitize a mortgage until 2003. By that time, Fan & Fred had already started the snowball rolling…
Understand first the way mortgages used to be made - read the threads on fractional reserve banking. In a system with a reserve fraction of 10%, a bank can loan out $9 for every $1 of currency it holds. That limits the amount of mortgages generated to nine times the amount of currency available to the bank. If demand for mortgages goes up, so too do interest rates, and vice versa.
Fan & Fred were created to securitize mortgages, which means, they bought those loan assets from the banks, which gained currrency reserves in return. The banks were able to vastly increase the amount of loans they made, to an (almost) inexhaustible extent. This flow of money into mortgages, regardless of how carefully F&F were on lending standards, led to a reduction in the cost of loans, which artificially increased demand. The increased demand for mortgages, and the houses they purchased, led to a perception that houses were a money-making investment. The perceived value of houses became disconnected from their fundamentals, and instead was based on the amount of money that could be made from a purchase. The Federal Reserve did nothing to contradict this perception, and in fact Greenspan pronounced several times that bubbles could not be detected and did not truly exist.
Mark to market accounting principles, dictated by the gov’t and blamed during the collapse for the sudden insolvency of institutions, led ratings agencies to rate all mortgages as safe, because, even if a borrower failed in payments, he could sell the house for a profit, or the bank could, in a foreclosure. In fact, no-money down became the rule for lenders because housing prices rose quickly enough to (seemingly) guarantee that a loan would soon be less than 80% of the value of the house. In the absence of a strong argument that houses were overvaluing, there was no good reason for ratings agencies to downgrade MBS’s. In fact there was a very good reason for them NOT to downgrade those MBS’s: The gov’t dictated that only those agencies that had a large market share would be accepted as raters for MBS’s. If Fitch’s had decided to downgrade, and lost bank customers because of it, they would have been sidelined by the gov’t. (See Reckless Endangerment )
Read the chart referenced above very carefully, It shows share of mortgages in percent, and the GSE’s are shown losing market share from a high of 50% in 2002, to a little under 40% by 2007. But the key is not what they did in the final run to collapse, but what they did to start the bubble. Here’s a chart of household credit market debt, a pretty good surrogate for mortgages outstanding:
Note that between 2000 and 2003, (mortgage) debt rose by over $2T - that’s mostly attributable to the influx of cash into the mortgage industry by F&F’s MBS’s.
Okay, so now it’s 2003, and F&F start losing their market share to private banks. Enter stage left, the Federal Reserve, which, for a period of over one year, and while GDP was experiencing a growth rate of just under 4%, inexplicably held the fed funds rate at 1%, providing a mortgage-Fed spread that averaged 5% over the period, the highest in over 30 years of records. By the time the Fed started raising rates, the Case-Shiller index had risen from it’s historical average of 100 in 2000, to 181 in mid 2004, with a >20% increase just the previous year. Pretty good return, huh?
The rest of what happened is simple bubble dynamics, as people rushed in to make huge gains on real estate, flipping houses, refi-ing for huge cash lumps, and trying just to get a house while they could still afford one. When the flow of money slowed, as it must inevitably do, the value of houses, based on the annual increase of home values, began to crater quickly. The use of MBS’s as money in the global markets let to a sudden devaluation of assets worldwide. Gov’t’s tried to inject cash with TARP, etc., but that just slowed down the inevitable unwinding of the financial imbalance.
Banks and Wall Street had their roles in this disaster, but they were supporting roles influenced by gov’t policies, the main of which was something called “affordable housing.”
BTW, look to 1934 to see the gov’t only option for cleaning up a bubble. The huge debt of WWI led to use of Liberty bonds and T-bills as money during the 1920’s. When it became clear that the gov’t couldn’t repay all that debt, the deleveraging of those securities in the market culminated in the 1929 crash. It wasn’t until 1934, when FDR defaulted on more than $20B in WWI debt, by reneging on gold convertibility and devaluing the dollar by more than 40%, that the markets became properly leveraged again and growth started. Unfortunately, the rest of FDR’s meddling caused growth to stall again in '37.
The only answer to the present malaise is to devalue the dollar so to increase the dollar price of houses above their mortgage amounts. The longer the government waits, the less drastic that action will have to be, but the longer we all have to wait to get on with our lives.
I strongly disagree that the only way out of the Financial Crises via bad mortgages is to devalue the dollar so that the nominal price for houses goes up above the current valuations. The only way out of the crises is to let the mortgage bubble collapse entirely – let the market adjust downwards – and then the market can take care of the devaluations. Devaluing the dollar would hurt the entire economy and the Federal Reserve had better not do that with the ensuing inflation or hyper-inflation. The only real solution is freedom in the market place. One does not help the bubble by continuing it. Let housing prices fall to the bottom so the market can take care of the rest of the problem. In short, capitalism is the solution, not further market manipulations by the government.
“The only way out of the crises is to let the mortgage bubble collapse entirely – let the market adjust downwards – and then the market can take care of the devaluations.”
I agree, though I am not confident that the government will let this happen as it should.
Another factor in all of this, though it’s seldom mentioned, is a declining birth rate: the bulk of Boomers are beginning to retire, and their peak producing/consuming years are behind them. They did not have many children – 1 or 2, maybe 3 – in contrast to the larger families they themselves came from. I read an interesting article by a David Goldman which asserted that sectors of the housing market would never recover because of this: the Boomers bought big luxurious houses way out in the 'burbs, but when it comes time to retire and move to smaller, multi-unit condos and townhomes nearer to hospitals, grocery stores, etc., they will sell these big homes to…who, exactly? To each other?
I’d say that the major source of causation flowed from regular and prime mortgages toward the sub-prime ones: via the effect on home-prices. When credit booms and flows to an asset-category, the price of those asset goes up. Typically, lower quality assets in that category go up in price as well (“rising tides lift all boats”). Thinking that prices of homes would rise was the single biggest factor inducing loans (including sub-prime loans) and all the more complex financial assets based on those loans.
The notorious Greenspan put and Bernanke’s “helicopter drop” reiteration of the put led people to assume that the Fed would try its best to ensure a floor under nominal prices of assets. This turned out to be a valid assumption. However, even the Fed can only do so much. The question then becomes: what type of floor can the government actually support. People who completely buy the government’s party-time theme (“use your home as an ATM”) are irrational. However, people who don’t get with the program and who assume that the government will simply sit by and do nothing, or who act as if we’re in a free-market are irrational in their own way. Government involvement in the economy is so high, that guessing correctly about government action is a major criterion for success. (Witness the recent upheavals in the stock market driven by ever changing guesses about what European governments will do about the debts of their “PIGS”).
In a free-market, actors who are using other people’s money are kept in check by those other people. However, when those other people are being back-stopped by government guarantees, this removes the most important check that a free-market would impose. When the recent crisis was clearly upon us, and Countrywide was clearly in trouble but not yet dissolved, they (Countrywide) tried to raise funds by offering CDs with slightly higher rates. In a free market, they would have had to offer a huge premium to induce people to invest. However, with the FDIC guarantee, putting money into their CDs carried only a small risk of inconvenience and slight delay in return of principal. A small premium of about 0.5% was enough to induce people to buy their CDs. If bad actors are not checked by funds drying up in such bad times how can one expect any checks during good times? [The same principle plays out with food and drugs: with the government being the rule-setter and proactive policeman in those areas, it drives out private-sector options, since people don’t see the point.]
Of course if the FDIC and the Fed were to tighten standards, if Glass Steagall were to be brought back, and so on we would reduce risk-taking. We could go all the way and reduce fluctuations to North Korean levels: stagnation and steady decline are the ultimate non-fluctuation.
Interesting analysis but I have a few issues.
First, the government has to intervene in the market to some extent, for example in setting nominal interest rates. Wouldn’t you rather have a system where investors are guessing what rational central bankers are going to do, rather than having a fixed stock of money that always and everywhere produces deflation. Wages are sticky to the upside so persistent deflation would be an utter nightmare for any economy.
Second, in your last paragraph you set a continuum of regulation from laissez faire to North Korea. The key for policy makers is to find a balance; to reduce reckless risk taking while still allowing people to risk their capital on ventures. The fact that regulators failed in this and actually exacerbated reckless risk taking doesn’t change the goal of successful policy making. It was done successfully in Canada which didn’t experience as much of a boom and bust because of minimum loan-to-value regulations. (I realise that Canada’s real estate is looking frothy at the moment but lets see if the BoC will raise rates.)
I strongly disagree that the only way out of the Financial Crises via bad mortgages is to devalue the dollar so that the nominal price for houses goes up above the current valuations. The only way out of the crises is to let the mortgage bubble collapse entirely – let the market adjust downwards – and then the market can take care of the devaluations. Devaluing the dollar would hurt the entire economy and the Federal Reserve had better not do that with the ensuing inflation or hyper-inflation. The only real solution is freedom in the market place. One does not help the bubble by continuing it. Let housing prices fall to the bottom so the market can take care of the rest of the problem. In short, capitalism is the solution, not further market manipulations by the government.
This is a liquidationist argument which is basically what turned a recession into the great depression.
EDIT:
Andrew Mellon, Secretary of the Treasury from March 4, 1921 until February 12, 1932:
liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.
I don’t think letting free markets work will cause a depression. Yes,housing prices would come down and a few people would be underwater on their mortgages, but without the free market operating and letting housing prices come down due to supply and demand things will only get worse, with the bubble further collapsing at some unpredictable date in the future. The government caused the bubble and the more they try to support it by manipulating the market the worse it will become. I say keep the government out of it altogether, and let’s have a free market in housing, including keeping the government out of interest rate determinations. Capitalism is the only way to go to correct the malfeasance of the government.
First, the government has to intervene in the market to some extent, for example in setting nominal interest rates. Wouldn’t you rather have a system where investors are guessing what rational central bankers are going to do, rather than having a fixed stock of money that always and everywhere produces deflation… The key for policy makers is to find a balance; to reduce reckless risk taking while still allowing people to risk their capital on ventures. The fact that regulators failed in this and actually exacerbated reckless risk taking doesn’t change the goal of successful policy making.
Govt intervention in the economy is ALWAYS a very bad idea as history endlessly shows. Professor Walter Block in his book “Defending the Undefendable” in Chapter 21 put it eloquently.
"… all government involvement in the economy has been marked by inefficiency, venality, and corruption, and the evidence suggests that this is not merely accidental… A government “enterprise” can be expected to be inefficient because it is immune to the selective process of the marketplace… This continual process of the selection of the fittest ensures the efficiency of entrepreneurs. Since the government is immune to it, it fails to regulate governmental economic activity.
The venality and corruption of the government is… even easier to see. What is difficult… is to realize that corruption is a necessary part of governmental operation of business… We readily concede that people enter business in order to gain money, prestige, or power… But when it comes to government, we lose contact with this basic insight. We feel that those who enter government service are “above the fray.” They are “neutral” and “objective.” We may acknowledge that some government officials are venal, corrupt, and profit seeking, but these are considered exceptions to the rule. The basic motive of those in government is, we insist, selfless service to others.
It is time to challenge this erroneous concept. Individuals who enter government are no different from any other group. They are heir to all the temptations that flesh is heir to. We know we can assume self-seeking on the part of businessmen, unionists, and others. It can be assumed just as clearly to be operative in government officials. Not in some of them, but in all of them."
– Walter Block
In a free-market, actors who are using other people’s money are kept in check by those other people. However, when those other people are being back-stopped by government guarantees, this removes the most important check that a free-market would impose… Of course if the FDIC and the Fed were to tighten standards, if Glass Steagall were to be brought back, and so on we would reduce risk-taking.
I agree with the first part. The second part is based on the wrong assumption that governments are better at regulating markets than private businessmen. Only the free market can do it, not regulations from politicians that can easily be bought and lobbied.