Are you aware of how banks that were very cautious pre-1913 were basically rendered unprofitable in the decades after the Fed was created?
No, why were they rendered unprofitable?
Are you aware of how banks that were very cautious pre-1913 were basically rendered unprofitable in the decades after the Fed was created?
I would like to know about this as well.
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.
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.
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.
Politically connected firms like Goldman-Sachs can take limitless risk because they get bailed out. Goldman-Sachs is a “smart one” too, but smart in a very different way.
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.
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.
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?
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.
@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.
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.
From ZeroHedge.com: Guest Post: The Collapse Of Our Corrupt, Predatory, Pathological Financial System Is Necessary And Positive
Wall St. is partly to blame. Like climate models, the popular financial models used for hedging risks are rationalistic constructs that must fail.
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.
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.
Since Goldman Sachs has set government economic policy in both the Bush and Obama administrations, the distinction being made between government versus Wall St. is no longer a relevant distinction. Welcome to fascism.
Since these companies in bed with the government are not themselves part of government, but are more advisers, yes they can win out (in the short run) via government policies they help to set. However, there is still force being used against everyone else who may disagree with those policies, and the taxpayer who doesn’t have much of a choice about where their tax payments are going; not to speak to the fact that each time the government bails out someone they tend to flood the market with printed dollars, making everyone pay the cost through inflation.