Eager to Regulate, Some Economists Reject Reality
Nouriel Roubini, a professor at the Stern Business School at New York University, says that the current fiscal crisis was caused by the failure of “the laissez-faire, unregulated (or aggressively deregulated), Wild West model of free market capitalism” and that nationalization of financial institutions and heavy regulation is a requirement of a stable economy.
Evidently Roubini is willing to overlook the two primary causes of the home mortgage debacle that has now spilled over to the economy at large:
- The aggressive regulation forced on Fannie Mae and Freddie Mac by the the Clinton housing bill that forced quotas on the lending institutions, essentially forcing them to take on risk far in excess of what the free market would have allowed.
- The greedy, grasping indulgence of American borrowers who, knowing full well that their means was insufficient to cover even the slightest increase in historically low interest rates, took advantage of federally mandated “access” to home mortgages that they had no hope of repaying.
That doesn’t sound like Wild West capitalism to me; rather, it sounds exactly like what one would expect from a market distorted and ultimately destroyed by governmental regulation.
Phil Gramm says:
By the time the housing market collapsed, Fannie and Freddie faced three quotas. The first was for mortgages to individuals with below-average income, set at 56% of their overall mortgage holdings. The second targeted families with incomes at or below 60% of area median income, set at 27% of their holdings. The third targeted geographic areas deemed to be underserved, set at 35%.
The results? In 1994, 4.5% of the mortgage market was subprime and 31% of those subprime loans were securitized. By 2006, 20.1% of the entire mortgage market was subprime and 81% of those loans were securitized. The Congressional Budget Office now estimates that GSE losses will cost $240 billion in fiscal year 2009. If this crisis proves nothing else, it proves you cannot help people by lending them more money than they can pay back.
Gramm’s last point is dead on target. The lesson that should be learned from the home mortgage crisis is that governments should stay the hell out of markets they either don’t understand or don’t care if they ruin.
The liberal notion that unqualified home buyers “deserve” to own their own houses is the root cause of the mortgage market’s implosion. It may be that additional regulation is required to steer the world economy out of the straits that government bungling took us into; however, that doesn’t change the fact that it’s misguided, anti-market policies that put us in danger in the first place.
Roubini does make one excellent point:
This crisis also shows the failure of ideas such as the one that securitization will reduce systemic risk rather than actually increase it. That risk can be properly priced when the opacity and lack of transparency of financial firms and new instruments leads to unpriceable uncertainty rather than priceable risk.
That’s exactly right. The financial industry was allowed to obfuscate the value – or lack thereof – of their loan portfolios by slicing, dicing, and rearranging their portfolios beyond recognition. This should never have been allowed. As Roubini says, “It was not that regulators were not empowered; it was that they were not alarmed.” Or not interested during the Bush administration’s reign.
The proper amount of regulation, contrary to Roubini’s thesis is simply this: just enough to keep the players in the game honest. In this case there were too many cheaters, in government, on Wall Street, and on Main Street.
Gramm’s analysis wholly ignores the impact of securitization. His focus on lousy subprime mortgages fails to recognize that the securitization of those mortgages is a separate and distinct process. Certainly, government facilitated the growth of subprime mortgages- but so did the private sector- nearly 50% of subprimes were not Fannie or Freddie’s. Regardless, this had nothing to do with the securitization process. Government did not force The Street to engage or indulge in that market.
The financial meltdown is a direct result of unregulated securitization process- the slicing, dicing and repackaging of bundled Alt A and subprime mortgages. Private rating agencies (S&P, Moody’s) found a way to give these complex instruments investment-grade ratings, thus facilitating massive sales. All of this fell squarely on the private sector; government did not regulate the process nor mandate the purchase of these high-risk plays.
All of this fell squarely on the private sector; government did not regulate the process nor mandate the purchase of these high-risk plays.
Chicken/egg, kreiz. The 1995 Clinton admin regulatory changes to CRA created the market for those securities, and Fannie and Fredie were both major customers and major originators of same. The government did not mandate the purchase of the resulting securities, but they certainly created the market conditions that themselves mandated that growing regional/national banks in an era of bank consolidation would have to buy them to remain in compliance with the CRA 1995 “red-lining” rules while growing and merging, especially if they were to compete in those five real-estate bubble states that fueled the bubble.
Such regulation always creates major potential for abuses. Saying that the private sector is the major responsible party is like stacking up a bonfire in dry conditions in a windy region, pouring gasoline on it, setting it alight, and then blaming the wind when the fire inevitably spreads.
Government definitely had a big role to play in the current crisis. Greenspan/Clinton/Bush pushed the housing bubble, then the repeal of Glass-Steagall allowed that bubble to poison the entire financial system.
And let’s not forget to also note the role of social policy advocates like Barney Frank in pushing banks to give loans to people who were unable to pay them, Chris.
Ain’t nobody clean in the housing meltdown. Every politician who has claimed that the other side is exclusively to blame (and Frank has been very vocal and explicit in making such claims) should be called out. Unfortunately, accountability won’t really exist until liberals like you are willing to call out other liberals and conservatives are willing to call out other conservatives. Until then, it’s just another partisan blame game while the economy burns.
Chris, I think the point though is that it was a combination of regulation in some areas and deregulation in others, along with a failure to account for unintended consequences, that created the perfect storm.
Kreiz is right that Wall Street was not forced to participate in the securitized mortgage market, but anyone with half a brain would know that they would do so to the maximum potential if permitted to do so. Investors exist to seek maximum profits, not to consider the systemic effects of their investments.
And as Tully points out, there WAS in fact a force by which government mandated the creation of more of these toxic assets- the CRA regulations which forced banks to have a certain percentage of high risk mortgages on their books. That coupled with the demand created by Wall Street was a recipe for the disaster that we’re now being served up.
It’s not clear how this whole process could have been regulated in a manner that would have prevented the disaster, so it becomes clearer that the whole process should have been avoided to begin with. You don’t help people afford homes by putting them in homes they can’t afford. You have to address the underlying fundamentals of the economy to create more jobs and better paying jobs first, so that people could actually pay for the homes they were buying.
For some odd reason, economists and politicians and investors alike all ignored some basic principles in their desire to cash in on this Ponzi scheme. There was a continued assumption that housing prices could rise indefinitely, even though the housing stock we were building was not backed by real money from qualified buyers. It should have been perfectly obvious that the game was going to end with music stopping and not enough chairs.
Jason,
You seem like you’re accusing me of being partisan here, when I clearly called out Bill Clinton in my brief post.
CStanley,
I wasn’t disagreeing with the idea that deregulation and bad regulation contributed to the mess.
On a side note, I do find it funny that rightwingers try to heap so much blame on Fannie and Freddie pretty much exclusively.
Marginally acknowledging the negative contributions of a past Democratic President who is often criticized by progressives for not being left-wing enough is a far cry short of being willing to acknowledge the past and ongoing failures of current Democratic Congressional leaders, Chris. It is still an open question whether you are capable or willing to undertake honest, non-partisan analysis and equitable standards of accountability even when doing so disadvantages your side of the partisan isle. Most of the blogosphere (left and right) is not capable or willing to do this. Are you?
Pots and kettles AGAIN, Chris. And anyway, I don’t exempt Republicans from criticism. Care to match me by specifically acknowledging the culpability of Barney Frank and the social engineers who forced the banks to give bad loans in the first place? Or are you going to continue trying to change the subject to talk about those horrible right-wingers EXCLUSIVELY???
Jason,
Ah, so now Barney Frank is more high profile than Bill Clinton. By the way, what Republicans did you negatively mention in your post?
No, I didn’t think that you were disagreeing with that idea, Chris, but I do think that you seemed to leave out the conclusion that I draw from it. It wasn’t just a mix of bad regulation and deregulation, it was the bad regulation part (the idea behind CRA that social policy could be implemented through this kind of market regulation- which led to a ‘free lunch’ mentality of getting poorer citizens into homes at supposedly no societal cost) which set the whole thing into motion.
And that’s why you have those ‘rightwingers’ heaping so much blame on that portion of the leadup to the current crisis. Incidentally, I’d also note that there are just as many leftwingers who choose to focus exclusively on the repeal of Glass Steagall, even though that in itself wouldn’t have led to the problems we have now. I do think that allowing banks to invest in securities necessitated better oversight (I have no idea why the SEC didn’t see the systemic risk of the CDOs, or why they didn’t provide any oversight on the ratings) but I still believe that if mortgage underwriting standards hadn’t been changed then there would have been a check on the supply side of this (a natural limit to the number of mortgages that were being securitized, and a lower risk due to the higher lending requirements.)
So, placing the blame more heavily on CRA and its proponents (esp as Jason points out, the proponents who silenced anyone who tried to sound the alarms, like Frank) is simply a matter of finding the deepest root to the crisis and the one piece which precipitated all of the rest. You can complain all you want about banks being involved in securities transactions, but those would not have had the risk factors hidden by legislative fiat had it not been for CRA, and damages would have been more self-limiting.
Chris, I’ve given almost a dozen classroom lectures on the financial meltdown and the economic crisis. In each of those lectures, I get the question of who is at fault. And my response is always the same — (1) Democrats are at fault for pushing policies that forced banks to give bad loans and condemned anyone who criticized such policies as a “racist” (and overwhelmingly powerful tool for silencing dissent); (2) Republicans are at fault for failing to regulate the derivatives market when they had opportunity to do so when they controlled Congress in the late 1990s (even when specifically given a bill that predicted the eventual consequences of uncontrolled derivatives trading); and (3) each of us as consumers are at fault for building up too much debt and using houses as some kind of magical piggy-bank.
I don’t exempt anyone. So consider your last attempt at evasion by redirection to be answered in spite of its irrelevance to the question that was put to YOU.
Now stop trying to change the subject. Are you or are you not willing to specifically acknowledge your party’s CURRENT leaders’ portion of responsibility in creating this mess?
No more distractions or redirections from you. Give a straight answer.
Jason,
No evasion intended, but I doubt I could lash the Democrats enough to satisfy your concerns. I played the Clinton card, you raised me a Frank card, and if I play that one, you’ll probably ask for a Baucus.
As to the specific question of Frank, I’m not well versed in his contributions to the current crisis, so for now I’ll take your word for it that he shares in the blame.
CStanley,
That all sounds about right to me. Like I’ve said, for a while now, we’ve known this crisis was coming. People have been talking about what John Cole refers to as the “big sh*t pile” of bad mortgages for at least three years if not longer. It’s supremely upsetting that no one even tried to do anything about it until after banks started imploding.
On a related note, did anyone catch the documentary “House of Cards”? I think it aired on CNBC about a week ago. I caught a small part of it during the late night re-airing and what I saw was pretty informative. I’m wondering if anyone saw the whole thing, or if anyone knows if there are plans to air it again.
CStanley,
A quick google search says it will reair on the 25th at 8pm ET.
Cool, thanks (I guess I should have thought of googling!)
Chris,
So now you try to evade the issue by indicting my alleged motives (which you complain about when done to you), eh?
It should hardly be surprising when people perceive you as partisan, given the way you dodge and weave whenever called on your evasions and prevarications whenever current Democratic leaders come in for criticism. You just can’t seem to stand letting that be the topic of discussion.
You’re providing a case study in the way the left is contributing its share to hyper-partisanship in the face of crisis, Chris.
P.S. If you really don’t know about Frank’s long-time championship of using lower bank loan standards as social policy, then I really don’t think you have the basic background knowledge to comment intelligently about this subject, certainly not to sit in judgment about what others who actually HAVE taken the time to research the key players may write about it.
Jason,
I evaded the issue? How? I complained about Clinton, and I accepted your argument about Barney Frank. Like I said, nothing was going to please you, so it’s not worth the effort. That’s not an “alleged motive” that’s the observable truth.
You talk a lot about Greenwaldian purity tests, but you seem to have your own bipartisan purity test of your own.
When did I do that?
You have no legitimate basis to make this assertion about my motivations, yet you persisted even after being called out for it. Are you trying to get banned?
Stop trying to make me the issue and give a straight answer or you will be banned. I’m tired of your evasions and distortions.