Been collecting a few of these links over the last week with some intent to write a short column about the topic, but that’s not happening, at least not in a timely fashion, so here are the links for those of you looking for further reading.
A Thumbs Up From the Ivory Tower: In general, econ professors approve of the idea of injecting capital into the banks rather than a government purchase of bad assets, although the new plan is far from perfect.
Gordon Does Good: Grumpy Paul Krugman gives credit to UK Prime Minister (and former Chancellor of the Exchequer) Gordon Brown for pushing the recapitalization idea when the U.S. was pushing the bad-asset purchase plan. I generally don’t agree with Krugman, but he presents a very strong argument here until he goes off the rails by saying that “All across the executive branch, knowledgeable professionals have been driven out; there may not have been anyone left at Treasury with the stature and background to tell Mr. Paulson that he wasn’t making sense.”
How did it all happen?: A sort of pop-psychology take on the fallacies and (bad) thought processes that played into the real-estate bubble and subsequent credit-market meltdown. It’s thought-provoking, but it’s all argument and no evidence.
Denmark Offers a Model Mortgage Market: George Soros is certainly not among my favorites – his attempts to buy the 2004 election for Kerry and his gleeful puncturing of Asian market bubbles in the 1990s come to mind – but he’s positively tame here in describing a safe, strong way to continue the securitization of home loans.
Hey Keith,
It seems odd to me that you are so confident that we have competent officials lining the administration, so much so that you would have to “go off the rails” to suggest otherwise. Are you really confident that the Bush administration will be able to capably handle this situation?
Also, I’m a little curious why someone like you (who strikes me as a libertarian) would be against someone using their right of free speech to influence an election.
Sorry, sure I come across as really sarcastic . I love your opinions or I wouldn’t read your blog, but sometimes your take on politics really throws me…
“Nobel Prize winning” might be a better descriptor but “Grumpy” also suits Paul Krugman.
Scott: What I think is off the rails is the claim that there is not a single “knowledgeable professional” in the executive branch who (could have) told Paulson that his original idea was cockamamie. He turned a strong column (idea B is right, idea A was wrong, and here’s why) into a political rant with that tangent, which, by the way, was presented without an iota of evidence (e.g., who are the knowledgeable professionals” who are gone from the Administration, and who are some of the underqualified people remaining in sub-Cabinet level positions?).
Soros didn’t use his “right of free speech” to influence the 2004 election; he used his money. Not exactly the same thing.
I guess, but it seems like a complete personnel breakdown of the executive branch is probably a different column (or series of columns). I compare it to you answering a chat question by saying “organization x doesn’t have a clue”, and someone saying you had gone completely off the rails because you hadn’t presented evidence and given a series of examples to back up your claim. He is a well-respected and prominent economist, and I would have to assume he has actual reasons to think that, right or wrong.
As far as Soros…I am all for limiting how much money politicians can spend on elections, but I’m pretty liberal. I’ve always pegged you as more of a libertarian, which I would assume means you are against government putting regulations on what people can and can’t do with their hard-earned money. But you’re always a little bit guarded about your political views, so maybe I am assuming to much.
Again, I don’t mean to be a jerk, but it seems like your problem is with people’s politics here. It seems like if Krugman was expressing a sentiment you agreed with, or Soros was supporting a candidate you liked, these things wouldn’t be problems.
I compare it to you answering a chat question by saying “organization x doesn’t have a clue”,
Big difference between a chat question and a column. I wouldn’t use a throwaway line like that in a column unless I’d already justified it earlier in the piece.
Your mistake re Soros is that you’re equating my dislike of his practices with a call to regulate or forbid them. I never said anything about regulations or prohibitions.
It seems like if Krugman was expressing a sentiment you agreed with, or Soros was supporting a candidate you liked, these things wouldn’t be problems.
Now you’re being a jerk. Why not just accuse me of bias and be done with it?
Just to expand on the Soros issue, I don’t dispute the validity of his actions – he saw that the currencies were inflated beyond any realistic valuations based on the fiscal states of the issuing governments. They had it coming. But his actions caused a good bit of economic harm to the people in those countries, and I didn’t see any indication that, say, he was willing to throw some of the millions (billions?) he earned to try to help lessen the impact of his actions on those people. My distaste is not for his financial decisions, but his moral ones.
Keith,
Doug Elmendorf (sp?), formerly of the Federal Reserve and now with Brookings, mentioned direct equity stakes in banks last month in the WSJ.
I suggest we’ll be dealing with systemic moral hazard in the financial industry for the next few decades due to the political nature of the current bailout/rescue.
Your characterizations of Krugman and Soros are spot on. Krugman’s assertion is just weird. When I read something like that, I see him getting a glazed look and spewing a lot of spittle during his diatribe. An angry man…
OK – I know I am making way too much of this now, and I need to get a life, but I would like to clarify my point. When you’re writing about baseball or food or books or whatever, we always know EXACTLY where you stand, right down to the amount of salt on your eggs. Which is great – I enjoy your opinions even when I don’t agree (which isn’t often), and you’re obviously a talented writer. It just seems like when it comes to politics, you are probably just as opinionated as you are about some AFL prospect. But for whatever reason, you won’t come out and say it. Instead you make some trite or straw man arguments against liberals while trying to stay above the fray. And that is what bothers me.
If you have no opinions about politics at all, and I am way off base, than I completely apologize. It is certainly possible that I am reading way too much in to this, and you would be just as upset about a throwaway line about the Clinton administration, or a rich Republican financier.
The one thing that baffles me about our political system is the fact that because an official is in Bush’s cabinet or the opposing party’s cabinet, it makes them unqualified or incompetent. One thing that must be realized is that in most situations, especially the economy our politicians want the same thing (low unemployment, positive growth, etc.) Where we differ is how to get there. I have no doubts that secretary Paulsen has some idea on how to do achieve some goals, but along the way better ideas will be presented. I think the livelihood of our economy depends on how he and others can sift through the vast amount of information and analysis they receive and make the best decision. Injected money into the banks was the first step and we weren’t the first to do it.
When Paul Krugman says that there isn’t a single “knowledgeable professional” on a particular staff, it pretty much means Paul Krugman himself isn’t on it.
Keith, in brief, your thoughts on the cause of the meltdown? “Wall Street greed?” “Deregulation?” Or bad loans to people who couldn’t pay them back due to over-regulation done with the noble intent of achieving social justice?
Odd that the party that has always favored ignoring sound financial practices in order to pursue “economic fairness” (read: socialism) is getting a major boom in the polls due to the crisis, isn’t it?
Keith, in your critique of Soros’ moral failings, you almost sound like a liberal!
I think pegging a single cause is probably asking to be wrong. We could argue over the most important cause, which I think is the surfeit of easy credit, a de facto policy that has been going on for 15 to 20 years. And, if this assertion is valid, it may not have been preventable: How politically feasible would it be to say that some people just will not be able to buy houses? Not only is home ownership seen as a near-universal right, but it allows taxpayers access to two classic “tax breaks for the wealthy:” the credits on mortgage interest and on property taxes. So if Clinton in 1995 or Bush in 2002 had come out and said, “I’ve proposed legislation to ban subprime mortgages,” they would have been pilloried.
The reality is that it is too risky for commercial banks to lend money to some people, due to lack of income or a history of poor personal financial management, unless they’re charging near-usurious rates. The scheme worked while asset values rose, but when they stopped rising (two years ago?), the illusion was dispelled.
I was surprised, however, by the speed of the deterioration in credit markets, and the degree of the resulting investor panic (egged on by a cheerleading media). That should be fodder for a lot of econ papers and theses over the next decade.
LM,
Great point on Krugman. LOL.
I work for Chase Mortgage and I’d like to give you my 2 cents on this financial crisis (of course I don’t speak on behalf of Chase).
The short answer is affordable housing pushed by a continual agenda of homeownership from LBJ to Bush 43, and especially, Congress to buy votes – you have got to hear Franklin Raines testify that mortgages are a “riskless” asset. Once demand for subprime securities peaked – pension funds, endowments, sovereign wealth funds – Wall Street greed ran with the incentive. Had Glass Steagel not been overturned by Gramm in 1990s, ML, MS, GS, and JPM would not have been able to merge or recapitalize utilizing a capital base built on deposits. In fact, I would argue that Glass Steagel and the regulatory regime would have made the current predicament much more problematic. The next question is what to do with the Basel framework and mark to market rules. I would also suggest changing state laws to make mortgages full recourse loans. The change would put more consumer pressure on home prices and mortgage contract terms.
What surprises me is that no one has raised the specter of incarceration. Is someone going to tell me that such a crisis occurs when law-abiding businessmen abide by the rules? Granted the rules aren’t perfect, but I’m betting people broke the law.
I do agree that Krugman is a grumpy man, prone to I-told-you-so-itis, but he did correctly predict a couple of years ago that housing was the next bubble to pop, and that it would do so spectacularly.
Also: I think Greenspan and his policies promoting cheap and easy money during both the Clinton and Bush administrations share some of the blame. All that money had to go somewhere, and it went into real estate.
Keith,
You also forget that Justice Dept lawyers were ordered to litigate against any bank not making subprime loans.
As for the speed in which the crisis spread, I’d have to say leverage * panic * mark to market. The combination probably had an exponential effect on the speed with which the crisis moved.
Everyone was talking about real estate being the bubble. But how do you pop it? Greenspan had to mitigate the effects of 9/11, enron, LTCM, Asian crisis, 1987 stock market crash, tech bubble, without rewarding bad behavior. We are fortunate enough to have survived all of these problems.
I’m not saying he should have reacted in completely the opposite way, but smart people were saying even then that there was too much money in the economy, and the only place people felt safe to store it was in real estate. Obviously, though, hindsight is 20/20.
And we survived those problems, yes, but we could be in for quite a pickle in the near future.
And the oil shock. The sudden spike in oil prices could easily have derailed the economy.
Incidentally, am I nuts, or does the recent ~40% drop in oil prices support the arguments of those saying the rise to $140-150/bbl was really speculation rather than reflective of weak supply forecasts? I still think trying to cap speculation in commodities markets is a bad idea, but I can’t see that the demand forecast has turned bad enough to slice oil prices in half.
Interestingly, when the OTC studied speculation in the oil market, they found that hedge funds were net short at 140-150. Goldman analysts changed their estimates from $200 to $75-$110.
We are seeing some insane levels of volatility. I guess we can thank leverage? Not sure about price manipulation – too large a market for anyone to really be a market maker.
I always thought it was speculation. Having previous worked in consulting for the oil industry, it was plainly obvious to me that even the increase in demand from China and India could not account for the spike we had over the course of a year or two.
But to stay with that theme for a minute, as much as it impacted my pocketbook — which it did, as someone who commutes 40 miles daily — I was glad that prices were high; people were finally being more responsible in their consumption habits.
Keith,
You’re right in the sense that it is probably inappropriate to nail a single individual on this mess, or to pin it to one cause or another. But while the media panic has been centered on “the end of western capitalism” isn’t there a more accurate description of the situation? One that focuses on the dangers of social engineering in general?
This bit of information told me a lot about the absurd ease with which home loans were granted…
“Sources of Income: In addition to primary employment income, Fannie Mae and Freddie Mac will accept the following as valid income sources: overtime and part-time work, second jobs (including seasonal work), retirement and Social Security income, alimony, child support, Veterans Administration (VA) benefits, welfare payments, and unemployment benefits.”
Source: http://www.foxnews.com/story/0,2933,424945,00.html
The last two items give me the most pause. If you’re receiving welfare payments or unemployment benefits, you shouldn’t be getting any sort of loan. Especially a home loan that will be securitized and dispersed across the financial world.
Don’t want to get into this too deeply, but can we all agree that when people say it’s primarily the fault of poor homeowners, it’s usually a proxy for minorities?
Lots of rich foreign condo speculators didn’t pay their mortgages either, Malcolm.
I would also argue, that if you own a home, you aren’t poor.
I think plenty of plain ol’ white Americans bought homes beyond their abilities to pay. Whether it’s because they bought twice the square footage they really needed or they bought in an area they might otherwise not have afforded, they are definitely a part of the subprime problem. So it’s a corollary to what I wrote above: Some people just won’t be able to buy houses, and some others just won’t be able to buy the houses they think they should have.
FQ — Thanks, I wanted to make that point as well, but I figured I was already opening up a potential can of worms. But you’re right, at least homeowners have equity! As a renter, I have none.
Keith,
I have to say I think the Krugman dig is unfair. He wasn’t going off the rails at all.
His column was about Brown’s influence in the capital market stabilization plan. How is it “going off the rails” to make the salient point that the US Treasury Dept was not responsible for this solution, and that should be troubling to Americans.
Krugman acknowledges that his statement on the Treasury Dept’s lack of depth of knowledge and stature is conjecture (note the word “may”).
But as Krugman sees it, Treasury was on the way to fouling this up, and if he’s right, that isn’t an unfair conjecture at all.
He wasn’t trying to write an economics lesson. The column is on the “Opinion” page of the NYT. It isn’t going off the rails to give one.
I’m a renter too and renting is going to get very expensive – as if that weren’t the case already.
I heard yesterday that Chase will no longer provide financing for condo buyers in Florida – regardless of the size of the down payment and the loan-to-value ratio.
If I had a bag of gold bullion, I’d be sitting pretty right now.
Well, I just hope that Question 1 in MA (repealing the state income tax) doesn’t pass, because my landlord has already said that when the inevitable property tax hike comes to offset the loss of revenue, it’s getting passed on to me.
“Don’t want to get into this too deeply, but can we all agree that when people say it’s primarily the fault of poor homeowners, it’s usually a proxy for minorities?”
I do agree that some use this as a way to spit their racist tendencies, but not all. More importantly, bringing race into it was exactly what got us deeper into subprime mortgages. When people cried foul about throwing mortgages to anyone who wanted one, and called for scale-backs, shifty politicians cried racism to shun them.
Businesses should be run based upon strong financial principles and mitigated risk taking, not on doing what’s perceived as socially acceptable. It’s about operating with facts, not feelings.
LM- “Odd that the party that has always favored ignoring sound financial practices in order to pursue “economic fairness” (read: socialism) is getting a major boom in the polls due to the crisis, isn’t it?”
I’m stunned at how a party is planning on fixing this mess using the same ideals that contributed to this mess in the first place. But if their challengers can’t convey that message, they failed and don’t deserve to win.
The first time I voted, I was a resident of Attleboro – the fart of the commonwealth. I remember seeing a question on the 2000 ballot to repeal the income tax which lost by a 52-48 margin – very close considering no one really thought it had a prayer of passing. I’ll laugh myself silly if the residents of taxachusetts pass that intiative. I’m sure Gov Patrick is quite peeved that he may lose a huge revenue stream.
Well, he just cut $700 million in spending today and fired 1,000 people. And he still has $800 million to go. I don’t think he’s enjoying himself much today.
Another Boston massacre… if state jobs in MA aren’t sacred, what is?!
I agree 100 percent, Chuck. The Republican Party has been utterly incompetent in its PR response to this crisis, and it starts at the top, in the Bush White House and the McCain campaign.
Their incompetence has put them in a position where they’re forced to accept the liberal story line (big, bad, greedy Wall Street evildoers wreaking havoc on the lives of ordinary Americans), which has forced them to spout this populist garbage (“Wall Street/Main Street” **BARF**) and made them look like cheesy panderers.
I’m neither a Republican nor Democrat, but come on, Pete, both parties are responsible for the mess, both parties spout that Wall Street/Main Street BS, and both parties are cheesy panderers. And no one has been talking more forcefully about “greedy Wall Street evildoers” than McCain.
And no one has been talking more forcefully about “greedy Wall Street evildoers” than McCain.
That would be John “Keating Five” McCain, right? He had no trouble taking money from those Wall Street folk back in the day.
If you want to point the finger at anyone in government, it has to be at the Fed, right? This is a monetary-policy issue rather than a fiscal one, and as I said above, putting limits on consumer debt was a political non-starter. I hadn’t considered FQ’s point before, but “financial redlining” has been both a media and academic hot-button for a decade or more.
Keith,
I’m with you that monetary policy bears the brunt of the blame there.
I may need to go back and check my facts, but it seems like, starting around 1999, whenever any economic indicator looked like a downturn was coming, the Fed lowered interest rates. And again. And again. And again. When capital is essentially free, risk becomes the only aversion to debt accumulation, and if people can’t properly calculate the risk (as they so clearly failed here), the system is in trouble.
It was an unsustainable set of responses that were an attempt to combat what likely would have been a mild economic downturn.
I agree, malcolm — my point is more related to political strategy than policy, and it’s that McCain’s (and, by extension, the Republican Party’s) populist strategy has left him with no chance at all. At least the Democratic position lines up with the party’s ideals.
Wasn’t McCain completely exonerated in the Keating scandal? I was under the impression that the only reason his name was never removed entirely from the investigation was because the other 4 lawmakers were democrats, and they wanted to avoid making it a partisan issue.
But I think the whole credit mess, or at least the government’s role in it, illustrates the single strongest argument against big government socialism. And that is the overall lack of accountability within the government leads to extreme moral hazard potentials, as well as the fact that many of these lawmakers, god bless them, don’t really know what they’re doing.
I find it odd that everyone blames the subprime mortgages and those who took them in the same breath as Fannie Mae/Freddie Mac. Perhaps I’m wrong on this, but isn’t the very definition of “subprime loan” one that neither entity would accept?
Also, the mess in the banking system right now is not the direct result of greedy, poor homeowners as much as it is the fact that their loans were treated as rock-solid investment vehicles (or “instruments”, if you prefer.)
LM-“But I think the whole credit mess, or at least the government’s role in it, illustrates the single strongest argument against big government socialism. And that is the overall lack of accountability within the government leads to extreme moral hazard potentials, as well as the fact that many of these lawmakers, god bless them, don’t really know what they’re doing.”
Good point. This is essentially what Freddie Mac/Fannie Mae were. Organizations that took huge risks because they would reap any benefits, while the government would foot any reprecussions.
Rob- agreed. But I think most of the offhand attacks on the people are a result of candidates and media that choose to solely blame wall street. There’s plently of blame to go around in this.
What I can’t understand is, and maybe I’m over-simplifying this- how would risky mortgages ever be a good investment? How could anyone ever see prosperity in that?
Rob: My understanding is that the FM’s were absolutely buying those loans. The WSJ editorial board was hammering Congress for allowing the two “quasi-governmental agencies” to accumulate ever-riskier portfolios when I was still a subscriber, so we’re talking at least five years ago.
Chuck summarized their POV quite well, now that I look at it. “Quasi-governmental” means government covers the downside, but doesn’t reap the upside.
I think risky mortgages looked like a good investment because the interest payments were big and the default risk looked lower than it actually was. As long as the economy was growing and asset values were rising, it was all good.
Perhaps I’m wrong on this, but isn’t the very definition of “subprime loan” one that neither entity would accept?
They’re not a bad deal for the borrower given two major conditions. One was just pointed out by Keith, that as long as the value of the asset continued to increase, it wasn’t a problem (in addition to the general feeling that the borrower’s income will continue to rise as they get older and advance their careers.) The second involves the fact that many (not all, or even most) of these loans didn’t require a down payment. If I have no down payment liability, I’ll be happy to pay a $300,000 mortgage on a $350,000 home. But when the home price crashes (or the rate on the adjustable-rate-mortgage increases), and I’m paying, say, a $300,000 mortgage on a $250,000 home, I’ll cut and run, let the bank foreclose, and go back to renting.
The two below episodes of This American Life explain things quite well. The first (first broadcast in May) is about the housing bust, the second (a couple of weeks ago) about the subsequent financial crisis. They are smart, in-depth yet clear, and entertaining to boot.
“The Giant Pool Of Money”
http://www.thislife.org/Radio_Episode.aspx?episode=355
“Another Frightening Show About the Economy”
http://thislife.org/Radio_Episode.aspx?sched=1263
I’ve done a lot of reading over the last six months about both the housing bubble and the financial crisis. I’d have saved myself a lot of time if I’d just listened to these two shows.
The next question is how the subprime mortgage market failure, due to Fannie and Freddie’s failure, led to the credit crisis. Being a corporation right now is very difficult. How does the mortgage market affect Ford’s and GE’s ability to issue commercial paper? Last I looked, both companies aren’t primarily in the mortgage business. It’s amazing how fast this crisis has affected indirectly related businesses.
@FQ
My understanding is that the credit crisis is more influenced by the failure of Lehman Brothers than by anything Fannie Mae or Freddie Mac ever did. Basically, the idea is that the investment banks were in a similar position as the subprime borrowers (not lenders). Other banks, hedge funds, and investors loaned Lehman money by buying up their corporate bonds (backed by dubious mortgage securities). When Lehman went bankrupt, it defaulted on those loans, which made every other bond portfolio look suspect. The banks are short for cash anyway, and therefore pulled back extending credit for fear that if Lehman can go down (and AIG was right behind them) then anyone could be next.
FWIW, Krugman wrote a piece for Slate many years ago detailing a similar situation in a babysitting co-op in Washington, D.C. Basically, the system got stuck because too many people were chasing not enough currency.
The real question is just what happens if the injection of capital only stems the tide. i.e., What is the next shoe to drop?