Prescience on the CRA and the current financial debacle
posted at 5:10 pm on November 17, 2008 by Ed Morrissey
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Two months ago, I noted how a September 1999 article in the Los Angeles Times praising the Clinton administration’s enforcement efforts of the Community Reinvestment Act inadvertently showed how they created the housing bubble by praising all of the excesses of the White House and Congress. King Banaian pointed out a City Journal article from the following year that took a much-less complimentary look at the CRA and government use of it — and predicted almost exactly what would follow eight years later. In fact, it also predicted the scope of the collapse:
The Clinton administration has turned the Community Reinvestment Act, a once-obscure and lightly enforced banking regulation law, into one of the most powerful mandates shaping American cities—and, as Senate Banking Committee chairman Phil Gramm memorably put it, a vast extortion scheme against the nation’s banks. Under its provisions, U.S. banks have committed nearly $1 trillion for inner-city and low-income mortgages and real estate development projects, most of it funneled through a nationwide network of left-wing community groups, intent, in some cases, on teaching their low-income clients that the financial system is their enemy and, implicitly, that government, rather than their own striving, is the key to their well-being.
The CRA’s premise sounds unassailable: helping the poor buy and keep homes will stabilize and rebuild city neighborhoods. As enforced today, though, the law portends just the opposite, threatening to undermine the efforts of the upwardly mobile poor by saddling them with neighbors more than usually likely to depress property values by not maintaining their homes adequately or by losing them to foreclosure. The CRA’s logic also helps to ensure that inner-city neighborhoods stay poor by discouraging the kinds of investment that might make them better off.
It did much more than that, though — it empowered “community organizers” as the shock troops of the CRA:
By intervening—even just threatening to intervene—in the CRA review process, left-wing nonprofit groups have been able to gain control over eye-popping pools of bank capital, which they in turn parcel out to individual low-income mortgage seekers. A radical group called ACORN Housing has a $760 million commitment from the Bank of New York; the Boston-based Neighborhood Assistance Corporation of America has a $3-billion agreement with the Bank of America; a coalition of groups headed by New Jersey Citizen Action has a five-year, $13-billion agreement with First Union Corporation. Similar deals operate in almost every major U.S. city. Observes Tom Callahan, executive director of the Massachusetts Affordable Housing Alliance, which has $220 million in bank mortgage money to parcel out, “CRA is the backbone of everything we do.”
In addition to providing the nonprofits with mortgage money to disburse, CRA allows those organizations to collect a fee from the banks for their services in marketing the loans. The Senate Banking Committee has estimated that, as a result of CRA, $9.5 billion so far has gone to pay for services and salaries of the nonprofit groups involved. To deal with such groups and to produce CRA compliance data for regulators, banks routinely establish separate CRA departments. A CRA consultant industry has sprung up to assist them. New financial-services firms offer to help banks that think they have a CRA problem make quick “investments” in packaged portfolios of CRA loans to get into compliance.
And what did all of this activity do? It forced banks to make bad loans, and in some cases without down payments — which splintered the informal CRA alliance of community organizers. One group in particular, NACA, declared down payment requirements “racist” and insisted on issuing mortgages without them. Even other CRA-based activists saw the damage this would do to marginal neighborhoods, but eventually Fannie Mae and Freddie Mac incentivized sub-prime loans so much that no-down mortgages became de rigeur.
Now that these loans have begun defaulting at high rates, what will happen to these neighborhoods? Probably what Howard Husock predicted in early 2000: they will deteriorate, thanks to a lack of commitment by homeowners already or almost forced out. Thanks to a lack of credit, it may take years to even start reversing that damage.
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Slightly OT:
I was cleaning up the bar that I work at last night, and a replay of “Face the Nation” was on. Barney Frank’s loathsome face was on and he was sputtering some nonsense. One of the guys I work with said, “Hey, look! It’s your favorite Democrat!”
Apparently my disdain for Barney Frank is well known at Kelly’s.
Badger in KC on November 17, 2008 at 5:15 PM
Only one answer:
http://www.bushmaster.com/catalog_military_MCWA2F14M4.asp
Bishop on November 17, 2008 at 5:19 PM
The City Jurnal article was written by Howard Husock. Who is he? Any chance of you interviewing him Ed?
D0WNT0WN on November 17, 2008 at 5:19 PM
I want to know when Congress is going to have one of its notorious investigations. Dodd, Frank, Schumer, and a whole nest of these vermin need to go to jail!!
Dammit I’m mad. Every time I see a story on these guys my face goes red.
The Dems are using this as an excuse to nationalize the entire private sector; banks, autos, WTF is next?
DerKrieger on November 17, 2008 at 5:26 PM
“Social justice” courtesy of Obama and his band of merry thugs. (And yes, I know Obama didn’t write the CRA, but he was one of the sleazy lawyers happily using it to extort banks).
It’s so good to know that the idiot politicians who’ve trashed our economy have just been rewarded by idiot voters. Four more years of these fools running things and we’ll all be unemployed and bankrupt. There’s some great “social justice,” eh? — misery and penury for all.
AZCoyote on November 17, 2008 at 5:26 PM
That going back in time for sure to unravel the CRA Carter/Clinton social engineering experiment.
It failed and here we are…
If there were any justice in the world, Nouriel Roubini would have won the Nobel for economics.
“On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.
The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market.”
Kevin in Washington State on November 17, 2008 at 5:33 PM
When will the MSM do their GD jobs and report on this stuff. It doesn’t benefit them to cover the arses of the Dems if the entire financial system comes crumbling down.
DerKrieger on November 17, 2008 at 5:35 PM
Every government degenerates when trusted to the rulers of the people alone. The people themselves are its only safe depositories. – Jefferson
JP1986UM on November 17, 2008 at 5:36 PM
Yes, yes it does :P “Look capitalism just isn’t working! Free markets just aren’t working!”
This is why whenever anyone talks about the current crisis, I harp on the CRA. Because the CRA is the root of everything.
Hidden in that article is something else – the repeal of the Glass-Steagal Act.
These two things together set the stage for everything that came after. All the crazy securities, the total global meltdown, everything. All because of the CRA.
apollyonbob on November 17, 2008 at 5:37 PM
He probably will about 20 years from now.
Illinidiva on November 17, 2008 at 5:38 PM
Take it from me -It’s not just the poor who have been saddled with deadbeat neighbors who left their property values depressed.
Other than that detail, that’s one prescient article from the great City Journal. The author would make a great hire in the Obama Administration.
Just dreaming…
Buy Danish on November 17, 2008 at 5:38 PM
Unfortunately, the republicans were serving a minority role even though they held the Presidency, the Senate and the House.
They marginalized themselves by taking on marginal issues. Imagine a reverse situation. Libs hold all three spots, and there is something that does not fit with their philosophy. They’d have tens of hearings, well coordinated.
We don’t have a Waxman, Schumer, Kennedy, Boxer. We don’t have the attack dogs, we have the country club guys. Maybe they are good managers, maybe they’re right on most issues, but they get chewed up and spit out every time.
Would a Lib President fail to defend his policies against constant sniping?
Obama said that he’d bring a gun to a knife fight. Ha, our guys are totally out classed in a knife fight. They will run scared in a gun fight.
Can we blame the Washington Social scene? Or the Press? Sure, to a point….but leadership is all about leading, not fretting about what some bimbo says about you.
r keller on November 17, 2008 at 5:39 PM
Badger, I will be in KC for Christmas. We always go to Kelly’s, I will ask for you.
Harpoon on November 17, 2008 at 5:42 PM
They have not found a republican to hang this on
driver on November 17, 2008 at 5:42 PM
Am I wrong or is the Community Reinvestment Act STILL in place? Has ANYTHING been done to correct the stupid moves that got us to this position?
By the way, how’s that whole ethanol thing going for us???
Star20 on November 17, 2008 at 5:45 PM
Social engineering in the economy (because liberals know that they cannot just redistribute wealth, directly) always leads to bad consequences. Of course, now we have an affirmative action President, and the damage done by the idiotic CRA will pale in comparison to how much BHO screws our country up.
I do not expect the United States to survive a BHO Presidency. Whether it be secession or insolvency or a total dilution of US citizenship by printing up citizenship papers for every illegal who managed to steal into our country, or a general disintegration of society, the US will not emerge from this experiment intact.
progressoverpeace on November 17, 2008 at 5:49 PM
Looking at the larger picture, my guess is that there were who were old enough in the 60’s and spent careers working on social issues closer to leftist activists who grasped that the capitalist system was being hijacked for it’s eventual destruction.
Politicians on right, being so eager to avoid charges of racism, were clearly set up and exposed largely as McCain-like naive chumps when it comes to understanding subversive political movements in general, and Marxist thought specifically. This is going to end very poorly. The goal, hard as it is to grasp, was never to build a greater America and is not now to recover America’s former glory. Those on the right who think it’s time to “move on” in McCain-like fashion while Barack takes it from here are going to experience another rude awakening. The political downhill slope will be more slippery and steep than the financial one.
econavenger on November 17, 2008 at 5:52 PM
80% of sub-prime loans came from financial institutions that weren’t fully governed by the CRA. 50% of the loans came from institutions that weren’t governed by the CRA at all. CRA regulated institutions made subprime loans at significantly lower rates than independent mortgage companies. Coercion had nothing to do with why these institutions made bad loans. They made these loans for the same reason that Alan Greenspan endorsed these loans: (a) they were taken in by the housing bubble, and so didn’t regard default as a significant risk; (b) they could transfer risk through the poorly regulated market in packaged tradeable securities. Incidentally, sub-prime loans made by CRA-governed institutions were also far less likely to be packaged into the complex (and, it turns out, misleadingly rated) mortgage-backed securities at the heart of the credit crisis.
Jazzman on November 17, 2008 at 6:07 PM
Editing never pays.
…there were those who were old enough
econavenger on November 17, 2008 at 6:07 PM
Eight years later… This article could be headed…”While RINO’s Slept”….
RaisinsofWrath on November 17, 2008 at 6:13 PM
Remember the old saw, “Don’t get mad, get even????”
Dang it, we ought to all be calling, e-mailing, hounding our Congress people and Senators. The peoples’ voice was once strong–and I think it is still–reference last summer’s senate standoff.
Don’t let up, fight, fight!! (Oh, hell, I sound just like McCain, sorry).
Chewy the Lab on November 17, 2008 at 6:33 PM
Now it’s time to get serious about change:
econavenger on November 17, 2008 at 6:38 PM
Mispricing of risk cannot be quarantined in a system as large and complex as our financial system. It eventually propagates throughout the system, as arbs move in to take advantage of the differences, and that is exactly what happened.
And securitization was not the problem, but the fact that Fannie/Freddie had to only touch junk paper to impart its (implicitly) offical government stamp and turn it into AAA.
And, if you don’t think that coercion is what generated this market, then you have no idea what was going on. The government forced open a fake market based on mispriced risk to get rid of the policy of redlining and, when threatened that this market must be made to exist (with lawsuits, calls of ‘racism’, and other thug tactics), others finally rushed in to share in the profits. This is no different from the way that many decent people are now going to stop paying their mortgages to get government cash/mortgage relief that would, otherwise, only go to the wholly undeserving, whose irresponsibility and stupidity helped bring our monetary system to its knees. But you’ll be back complaining about how so many ‘decent’ people are the cause of the mortgage bailouts costing so much money …
progressoverpeace on November 17, 2008 at 6:40 PM
Well-said.
Buy Danish on November 17, 2008 at 6:43 PM
Water always seeks it’s own level.
MB4 on November 17, 2008 at 6:51 PM
Thanks, Danish. This whole situation just drives me nuts.
The normal response to redlining would have been for those communities to start building their own institutions, but actual work is considered too much of a hardship in the modern US. Investment banks were initially created because Jews weren’t allowed to play with the WASPs in standard Wall Street houses (and we all benefitted from that – until this CRA-generated fiasco). That same motivation is what built Central Park West (and interestingly, all of those developers went broke building it, as the depression came). But, liberals never think about working and creating new wealth. They just like trying to steal someone else’s.
progressoverpeace on November 17, 2008 at 6:57 PM
Remind me again how McCain failed to hammer Obama and the Dems with this, every day from when the crisis broke until November 4?
Ah yes – he was too busy trying to ‘out-wall-street-greed’ Obama.
Republicans need to find a way of keeping this issue alive over the next couple of years, and getting it into the public consciousness.
EnglishMike on November 17, 2008 at 6:59 PM
If you look too on how CRA was going to be used to make a whole lot of money from a minority community-based pyramid, the “Wall Street greed” also had its beginning in D.C. with govt policymakers and it had a connection to the Obama campaign. Robert Rubin could be the poster child to illustrate that. He helped set it up then jumped to Citigroup to cash in with Sandy Weill.
How many times did John McCain mention him during the campaign? Oh wait, that’s right, he couldn’t point fingers there because of Phil Gramm’s bipartisan role in the Glass-Steagall repeal debacle.
econavenger on November 17, 2008 at 7:20 PM
This story needs to stay in the “light of day” for a very long time until EVERYBODY understands it………….
Seven Percent Solution on November 17, 2008 at 7:31 PM
In that front page pic, Barney Frank looks like he came out of Monty Python’s Mr. Creosote sketch.
eeyore on November 17, 2008 at 8:15 PM
progressoverpeace:
The picture you have of the subprime crisis is wrong on so many levels that I don’t even know where to begin responding to you. So I apologize if this ends up being a little long and rambling.
First, it seems like you’re saying that CDO’s were over-rated because of investors’ unwarranted confidence in Fannie/Freddie. This is absurd. The truly disastrous sub-prime loans (no downpayment, no proof of income, etc.) could not legally have been backed by the GSEs, since they fail to meet federal underwriting standards. The prevalence of these loans is entirely attributable to private-label securitization, fuelled by a faith in the persistence of the bubble. CDOs backed by these loans were over-rated, but that paper could not have passed through the hands of Fannie/Freddie. So your claim that Fannie’s AAA rating is solely or primarily to blame for the mispricing of risk is just evidently false.
Second, the claim that securitization has nothing to do with this crisis is even more absurd. Now that we’ve dispensed of the myth that the GSEs are responsible for the failure of credit rating, we should ask, “Why were products backed by such dodgy assets given such good credit ratings?” And the answer is that the products were ingeniously created so that the risk was extremely diversified and massively overcollateralized. But the models used to calculate the risk didnt completely account for the ludicrously lax underwriting standards in the home loan market, or anticipate the country-wide housing slump.
So the creation of these complex securities, and the consequent transfer of risk from agents actually involved with the housing market and aware of the subprime situation to institutions with nothing to go on but the rating agencies’ inadequate models, is a crucial factor in the credit crunch.
To blame it on Fannie/Freddie or the CRA is to betray either a lack of understanding of the financial situation or a hyperpartisan lack of concern for the facts.
Jazzman on November 17, 2008 at 8:27 PM
progressoverpeace, interesting corrective post there.
A few questions.
Jazzman states that CRA-related sub-prime paper wasn’t involved in the packaged derivatives that made this turn-down so vicious and widespread; he also says that fully half of sub-primes had no inherent basis in CRA-related activities.
But didn’t the magic evil touch of the GSEs, as you noted, actually provide the key link here? Did the GSEs provide the implicit USG guarantee to the sub-prime paper that was NOT CRA-related, and didn’t that play a role in the AAA rating?
A more cosmic question: why would “regulation” be the answer to the derivatives market situation? Why does the mortgage-backed derivative market need any more regulation than it already has? So long as market players are free agents, and information is on the table, how is this market different than any other on Earth?
And I still don’t understand why Glass-Steagall repeal really had any role in this. Seems to me essentially the same problem could have developed with G-S in force.
IceCold on November 17, 2008 at 8:38 PM
I should add that the poor underwriting standards deployed by private lenders can be completely explained by the fact that the securitization process and the failure of credit rating allowed them to offload risk to this massive financial machine hungry for high-yield investment.
Every aspect of the subprime crisis, from the behavior of borrowers and lenders to the creation of massively complex and over-rated financial products, to the cavalier assessment of risk, can be accounted for as the product of agents behaving more or less rationally given the information available to them. Hypothesizing some kind of external coercion is not just unsupported by evidence but also explanatorily superfluous.
Jazzman on November 17, 2008 at 8:39 PM
As I stated in my previous post, the GSEs could not have backed loans that required no downpayment or proof of assets. So GSE involvement cannot account for the AAA rating of paper involving the high-risk loans.
Jazzman on November 17, 2008 at 8:45 PM
So Jazzman – the really bad/risky loans were securitized without any GSE involvement? Who did it? Weren’t there zero-down loans from the CRA-related activities, and if so who bought them?
Seems that several key points remain as they were, even if the picture you painted is more accurate than p-over-p’s picture: social-engineered loans are (surprise) almost always a bad idea; market participants are responsible for their own due diligence, which will generally be vastly superior to any regulatory regime – the bad risk-pricing models you cite must have been rejected by some institutions, because not all of them played in this area, but gave it a wide berth, I believe.
Thanks for the discussion – let’s step back for a moment and consider how this little informal chat is 1,000 times as substantive as anything one typically hears in the MSM or from elected officials, of either party ….. very troubling.
IceCold on November 17, 2008 at 8:46 PM
Agreed…and this is worth watching (for those who haven’t seen it yet)
jerrytbg on November 17, 2008 at 8:50 PM
wow… you guys know this stuff a heck of a lot better than I do. Thanks for the sane dialogue on this.
Can either of you provide examples of actual predatory lending? Obama’s web site had some verbiage about how lenders tricked borrowers by telling them they could afford more than they could actually afford? Who are the lenders to be telling who can afford what? The borrowers should know how much they make and how much they can afford.
Can you point us to any examples of actual predatory lending?
Thanks for the education. :-)
cannonball on November 17, 2008 at 9:12 PM
You cannot misprice risk in one section of the market and not expect it to propagate through the rest of the instruments. The arbs will effect this, and given the size of the markets we’re talking about, there was a ton of money to arb out of the mispriced risk in the government/pseudo-government/crypto-government fueled market. Think of it as if the government had decided to lower the sea level on the East Coast by 3 feet, and expected sea levels around the world to remain unchanged.
Oh, please. I knew what was going on. My trader friends knew what was going on. People wrote about the whole situation over and over. We all saw the 100% mortgage offers from all over the place and everyone knew the frothiness of the market and the loan situation. We all saw the skyrocketing prices, and remembered the last time prices had skyrocketed in the same fashion (just before the last housing bust).
As far as not anticipating the housing slump, I don’t know how young you are, but we have a rich history of housing slumps and had just come out of one not too long ago. We all knew that housing was in a bubble and we all knew it was going to pop – how many covers of Barron’s talked about the problems with housing? The only question was ‘when?’ To that end, we started seeing the best indicator of the end of a housing boom, which was the high-profile entrance of foreigners into the market. (Not many look at this part of foreign participation, but it’s one of the indicators that I like). If that wasn’t good enough, then the rise of oil prices should have alerted the less astute. That wasn’t secret information and, again, anyone with a memory remembers what happened the last time oil was doing that.
No. Ignorance of the market and the underlying instruments is not an excuse. Neither is relying on the models – as we all know that these valuation models all have large amounts of misvaluations in them, and the number of open parameters is always quite large and often filled in with guesses.
People were stuck in the mispricing and had no choice but to keep going. But everyone knew what was happening – everyone with a brain.
As I said above, everyone knows that the models are inadequate. Anything that involves future pricing is dependent on too many parameters that are unknown and impossible to know, while the actual value often diverges from the theoretical value – especially at the extremes!
Into this system the government decided to dictate risk pricing … so they could feel good about themselves and get reelected.
The CRA, and the subsequent intimidation and threats that were brought down on lenders kick-started a deadly mispricing of risk that was thrown into overdrive by Fannie and Freddie and spread throughout the debt markets.
In all your analysis, it’s amazing that you never saw any need to mention the credit default swaps, which served as the reservoir and secondary engine for the mispricing that had propagated up.
progressoverpeace on November 17, 2008 at 9:20 PM
The credit market is no different from any other market on Earth, and so it is just as susceptible to market failure as any other market on Earth. Asymmetric information at every step of the process (between borrowers and lenders, between lenders and companies purchasing CDOs) is a major reason for the failure of this particular market.
I am with you on Glass-Steagall. It it unclear to me that Gramm-Leach-Bliley played anything more than a marginal role in the crisis, and I’ve yet to see a good argument on why it’s to blame. I do think, though, that there is a need to come up with a new regulatory framework, one that is responsive to the technological advances that have made a market in highly customized securities (and the corresponding informational problems) possible.
Jazzman on November 17, 2008 at 9:25 PM
The left doesn’t even need taxes anymore.
They have figured out how to fund their idiotic, country-wrecking schemes through means that don’t alert the proletariat.
The CRA is one example. Billions redistributed to sloths with their hands out (but each hand only counts as one vote). As a bonus, Capitalism comes close to cratering!!! or maybe it does crate – can’t tell yet.
Tax cuts for 95% is another means. Orwellian. Taxes go up while the dummies in the trenches think theirs went down.
But the biggie is cap and trade. If the country isn’t destroyed by then, that’ll do it.
notagool on November 17, 2008 at 10:00 PM
Look, the fact of the matter is that in 2005 and 2006, when subprime lending really exploded, over 60% of mortgages were securitized by private institutions, and these include the most risky assets. Much of this risk was mispriced. You claim that this wouldn’t have happened in the first place if it hadn’t been for the implicit government guarantee behind Fannie/Freddie’s debt. This is an assertion that I can’t disprove because you haven’t suggested any mechanism for the propagation of mispricing beyond some vague mention of arbitrage. What I can do (and have done) is provide arguments that even in the absence of Fannie/Freddie and their implicit asset guarantee, the market was set up for a crisis. The burden of proof is on you, then, to show that the explanation involving Fannie/Freddie is more plausible. And just gesturing at shadowy arbitrageurs is not sufficient.
In fact, I don’t even think the subprime crisis was a necessary condition for the credit crisis. High-yielding asset classes were mispriced by unrealistic risk models in many different markets. If the subprime meltdown hadn’t triggered the crisis, it might eventually have been triggered by private equity or emerging market equity or any of a number of other assets/commodities. The lethal cocktail of securitization, credit default swaps (which I’m glad you mentioned) and massive leverage is inherently unstable in the absence of perfect information. The crisis was triggered by the subprime collapse, but it was the product of unregulated finance. CDSs in particular were basically beyond any sort of public oversight, a disaster waiting to happen.
Jazzman on November 17, 2008 at 10:15 PM
I should note that I’m not denying that Fannie/Freddie’s government guarantee distorted the market to some extent. I just don’t think the entire financial crisis can be attributed to it. I think it’s plausible that the recklessness of private institutions was partially driven by their belief that the Fed wouldn’t let Fannie/Freddie become insolvent, and so it would adopt an inflationary policy which would keep the housing bubble going. But there’s a difference between acknowledging that Fannie/Freddie was part of the problem (along with securitization, the unregulated CDS market, monetary policy, etc.) and laying the entire blame at the feet of the GSEs and community activists.
Jazzman on November 17, 2008 at 10:26 PM
If the CRA is still in effect, how will the bad loans ever stop?
Of course these programs are a way to funnel funds to left wing groups: just watch Obama pass legislation that will restore funding to Acorn, but this time under the table.
PattyJ on November 17, 2008 at 10:41 PM
I have no argument with that. We disagree on how the market got so skewed.
You can throw the ratings agencies into that mix. I think we can both agree that the ratings were off for almost the entire debt market. Now, how could that happen? Was it a political or a mathematical mistake?
One can look to the example of the brokerage houses and their insane recommendations for stocks in the 90’s – when for years not a single major brokerage had even one sell recommendation. Now, I am not saying that credit ratings and stock recommendations are the same – I understand they are very different – but the underlying mechanisms that lead to ratings bubbles in each are much the same. Credit ratings agencies must apply the same standards across the board (though stock analysts used to think that they were free to pick and choose among a set of independent models to use for any individual stock – which was a total joke) and must be sure that their ratings are consistent. I do not know the models or algorithms used by the credit ratings agencies so I can’t go into any detail on this. Perhaps you can.
I agree. Any slowdown in the economy could have served to start a cascade of calls on CDS’s. But the subprimes anchored a huge part of the market and, by themselves, generated enough losses (and corresponding non-existent profits from CDS’s that couldn’t pay off) to cause our Treasury Sec to talk about being “500 trades from Armageddon”.
Yes. And the only point we really seem to disagree on is why this market-wide mispricing happened. I say it came due to a small mispricing that forced the rest of the credit markets (which competed with it) to come into line (which was a mispriced line). You disagree. You think the mispricing came from people trading instruments who didn’t know what they were trading and knew they didn’t know what they were trading (from your other post – though correct me if I misstated your position on this) through all the securitized credit markets.
Perhaps, as I acknowledged above. But we really have no way of knowing. It depends on what credit markets failed, how bad the failure was, how the instruments and CDS’s were distributed through other businesses … But I am in general agreement with you, here, though a little less certain than you seem to be.
Considering the fact that we never have perfect information about even the present, let alone the future, it seems that you would never allow these elements (not all of them, at least).
I’m not sure we lack for oversight, here. Companies that sold CDS’s had to be clearing (for other trading activity) through many markets and their balance sheets were open, I believe, to examination by those clearing corporations (whichever ones) and probably a good number of regulators, though I am just guessing, here. It was not as if no one knew the humungous size of the CDS liabilities and the obligations that were being taken on. One had only to look at the obligations a company would have if interest rates rose 2%, say, to see the exposure and the possibility of defaults. A few friends of mine used to trade convertibles and they have been aware of the devastation caused by a small default for a long, long time.
Now, if these questions of possible liability were put to companies and they lied in their answers, that is one thing, but I don’t think the fact that everyone actively ignored the question means that regulation would help much of anything. Regulators can ignore facts as well as anyone and they are usually much better at it.
I am all for standardization and centralization of markets (and getting CDS’s out in the open, as much as possible) but that is different from implementing some new regulatory structure. I really don’t know how one can stop two companies from making private contracts if they want. And, when that happens, it is the responsibility of the companies to know what they are signing and take on the responsibilties and risks involved in the contract.
progressoverpeace on November 17, 2008 at 11:08 PM
Jazzman,
I would sum up my position by comparing CRA/Fannie/Freddie’s impact on the credit markets to Affirmative Action’s effect on our judiciary. Much of our judicial system was skewed by the need to have the clearly biased and unconstitutional rules of Affirmative Action (and minority set-asides …) pass Constitutional muster. There are many areas and rulings that had nothing to do with AA that were skewed because of precedents set by silly AA rulings that had to twist the underlying logic in order to arrive at the desired ruling.
This is only a rough analogy, but it expresses the larger picture of what I see having happened in our credit markets – though the propagation of distortions is much more fluid and much quicker in the financial system.
progressoverpeace on November 17, 2008 at 11:19 PM
The long demise of Glass-Steagall
The folly of this should be obvious. Banks should not be casinos.
econavenger on November 17, 2008 at 11:50 PM
Fair enough. This has been an interesting discussion and I’m glad we’ve clarified our areas of agreement and disagreement. Before going to bed though, I’d like to apologize to you for being so aggressive. I reread my second post and realized I should not have come out with guns blazing. In particular, I apologize for insinuating that you lacked an understanding of the financial situation. While I still disagree with much of what you’ve said here, I think you’ve amply demonstrated that you haven’t approached this issue in a thoughtless manner. So please accept my apology and have a good night.
Jazzman on November 18, 2008 at 12:26 AM
And I also appreciate that you kept the discussion civil despite my earlier incivility.
Jazzman on November 18, 2008 at 12:26 AM
It was a good discussion, and an important one. I thoroughly enjoyed it. Thanks.
progressoverpeace on November 18, 2008 at 12:48 AM
There are some errors in the discussion, but this is the one that fries my gizzards.
The failure was due mostly to the failure of the buyers and sellers of assets to properly recognize the value of those assets. These buyers and sellers are professionals in a highly technical market. Both, but particularly the buyers, have powerful incentives to understand and properly assess the true value of the assets they’re trading.
If the professional buyers and sellers, who have incentives to accurately value the assets they’re trading, did not value them correctly, what possible element would magically equip a passel of bureaucrats to value the assets correctly?
The call for regulation is a knee-jerk, a reflex by incipient tyrants and control freaks to bring all things under their personal control, on the certifiably demented notion that they, the anointed, understand what the most intelligent and intimately affected cannot understand. It’s bunk from the first syllable.
There is nobody to blame for the purchase of improperly valued assets but the purchasers of the assets, except in those few cases where the valuation was the result of deliberate fraud.
philwynk on November 18, 2008 at 10:50 AM
When I say that there is a need for regulation, I don’t mean that I think the government should be involved in pricing assets, and it’s bizarre that you’d think I’d mean that. I’m thinking more along the lines of (a) disclosure requirements for CDS contracts should be strengthened, and (b) securities should be standardized, sort of like commodity futures contracts, so that prices are truly set by supply and demand rather than by computer models. Neither of these regulatory suggestions is motivated by any sort of tyrannical impulse. The motivation is to mitigate problems involving lack of information, so that the market can work the way it’s supposed to.
Jazzman on November 18, 2008 at 1:13 PM
Two other areas where I think some form of regulation might be efficacious, although I’m not entirely convinced:
(a) Excessive leveraging is a serious problem. Perhaps steps should be taken to disincentivize it.
(b) I’m concerned with the moral hazard problem created when companies become “too big to fail”. Those (like progressoverpeace) who think Fannie/Freddie’s implicit asset guarantee played a significant role in this debacle should concur. I’m not sure about the most suitable measures to deal with this problem.
Jazzman on November 18, 2008 at 1:24 PM
That’s a tough issue. No banking system can withstand a run on the banks, so all banking systems are open to drops in confidence causing a failure/collapse of the system the same way that no free government can survive a loss of confidence in its institutions (which we are also getting very close to, as our government has declined to carry out many of its most basic duties and has insisted on inserting itself into areas that it has no business messing around with). But we have to have banking and have to be open to the risk of systemic failure with a loss of confidence in the banks, no matter what restrictions are placed on banks.
I do concur that any company whose failure would be considered a serious threat to our monetary system presents a problem that must be addressed. But we already have more than enough regulators and structures that can deal with that, not the least of which being the Fed which is charged with maintaining the stability of our monetary system (not tweaking our economy).
Unfortunately, those regulators and structures have been abusing their power in order to hassle businesses who were never too big to fail and not even anything close to monopolies (as in the idiotic, sham case against Microsoft – which was never a monopoly and always had competition that was free for those who put a little time in – Linux, for example). At the same time we were not using these existing structures to mitigate the real threats that were around, but instead promoting and helping them become even more dire threats, especially the quasi-government entities.
I think the clearest lesson about this whole debacle is that no one has been held responsible. Barney Frank is still running his committee. Maxine Waters used her time questioning Paulson (when this all first started) to try and extort money and work for minority and women-owned businesses managing the pile of assets that was going to come through the bailouts – for which she should have immediately been thrown out Washington and possibly jailed (I kid, but not much). Recipients of mortgage rejiggering have had to give up nothing for the free money from Washington. I think that, if someone made a cost of having the Feds come in and help them out (losing their voting rights for 30 years, for an example of a non-monetary cost that many would consider dear and many others would consider benefical to the rest of us) then others would not be so incensed at these people getting paid for their irresponsible behavior that imperiled us all. People still have a legitimate right to be mad about what is happening, but if there was at least a cost of some sort to those benefitting it would not tick people off so much and would help instill some confidence in government rather than draining it – which will destroy us all.
That was kind of rambling on my part. I hope I addressed the actual point somewhere in all that.
progressoverpeace on November 18, 2008 at 2:45 PM
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