I’ve already made up my mind! (Big think, et al)

I’ve talked a lot about “expert opinion,” and also about the power of the zeitgeist.  This post will explore a few more examples.  Let’s start with an interview with the chief economist at Moody’s.  This Q&A caught my attention:

Question: You wrote in a recent paper. “It’s no coincidence that the great recession ended just as the stimulus package began providing its maximum economic benefit.” How do you know? (Steven Landsburg, The Big Questions)

Mark Zandi: Well, it’s a good question.  I mean, we can look at individual aspects of the stimulus package and then look at the parts of the economy to which that stimulus would have an impact.  So for example, the Cash for Clunkers, we know that that had a huge effect on vehicle sales and helped turn around vehicle production and employment in the vehicle sector.  The First Time Homebuyer Tax Credit, the housing market stabilized this summer.  Housing prices actually have risen a little bit in the last few months.  Now there are many reasons for that, all of them policy related, but one of the key policy aspects that helped the market was the First Time Homebuyer Credit.

Consumer spending stabilized, and consumers got tax cuts, Social Security recipients got checks, so I think it helped there play a role.  Without help from the feds, states would have been cutting.  Let me just give you a statistic.  In the year ending in the second quarter of 2009, state and local tax revenues fell by $120 billion.  On a percentage basis, we’ve never seen anything like that, $120 billion and in that same year; aid from the federal government to state and local government increased by $110 Billion, so almost a complete offset.  Not complete in some states, but localities have been cutting programs and jobs and raising taxes because they still have a budget hole, but could you imagine what they’d be going through had they not gotten that help.

You have to think about what the world would have looked like without the stimulus.  You’ve got to construct a counterfactual, but in the case of state government, I don’t think that very hard to do.  You can ask any governor and they’ll pretty much tell you that the stimulus was very important to keeping their budgets together as well as they were kept together.

It is hard to know what to make of this.  I think everyone agrees that output will rise if you subsidize an industry.  That’s economics 101.  But it isn’t macroeconomics; it’s microeconomics.  Why would a good economist make this argument?  I recall a few months back reading someone argue that in grad schools today students are taught a lot of highly technical models that seem to have little to do with the real world.  Perhaps when students get out and confront real world problems they find that what they learned in grad school is useless, and sort of unconsciously revert back to something they do understand–supply and demand.  Or maybe there is something that I am missing here.  But I just don’t see how Zandi’s answer relates to the question Steven Landsburg asked.

It seems to me that Zandi just sort of assumes that fiscal stimulus works, and went out to look for evidence to confirm this bias.  Regarding his counterfactual of no fiscal stimulus, I have argued that if fiscal stimulus had not occurred, the Fed would have engaged in monetary stimulus.  And since monetary stimulus is much more effective than fiscal stimulus, the recovery would probably have been much faster.  BTW, as long as output is growing below trend and unemployment keeps rising, I think it is premature to talk about a recovery.

My next example is from the Wall Street Journal:

WASHINGTON””Jeffrey Harris, the chief economist at the U.S. Commodity Futures Trading Commission who last year said he could find no direct link between speculation and high energy prices, is leaving the agency and returning to academia.

Mr. Harris’s departure comes at a critical time for the CFTC, which plans to unveil a major proposal to impose new trading limits on crude oil and other energy futures products.

CFTC Chairman Gary Gensler is the driving force behind the proposal, saying it is the CFTC’s duty to protect the American public from excessive speculation. He is pushing for the consideration of new limits, even though the agency’s economic team reportedly found no evidence of a causal link between excessive speculation and last year’s record crude-oil prices.

Good to see that with Bush out of the way there will be no more “faith-based” policy decisions.  Everything will be based on hard science.  Seriously, isn’t this just the zeitgiest again?  It seems like the high oil prices were due to speculation, so that’s what people will believe, regardless of whether or not there is any evidence.

And this doesn’t just affect people on the left; consider the title of a recent book by Judge Posner; A Failure of Capitalism.  How do we know it was a failure of capitalism?  Because it seems like one.  It didn’t seem like the crash of late 2008 could be caused by tight money, so it wasn’t.  (Of course here I am using the post-modern definition of “truth.”)  And it seemed like the sub-prime fiasco was caused by private banks, so that’s what everyone assumed last year.  Even I made that assumption.  Kudos to those commenters who disagreed with me, as there is increasing evidence that you are correct.  This is from an article by Peter Wallison:

Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks.

How did Judge Posner, me, and many others come to the wrong conclusion in 2008?  Partly it was due to government fraud:

Most of the damage was done from 2005 through 2007, when Fannie and Freddie were binging on risky mortgages. Back then, Mr. Frank was the bartender, denying that there was any cause for concern, and claiming that he wanted to “roll the dice” on subsidized housing support.

In 2005, the Senate Banking Committee, then controlled by Republicans, adopted tough regulatory legislation that would have established more auditing and oversight of the two agencies. But it was passed out of committee on a partisan vote, and with no Democratic support it never came to a vote.

By the end of 2008, Fannie and Freddie held or guaranteed approximately 10 million subprime and Alt-A mortgages and mortgage-backed securities (MBS)””risky loans with a total principal balance of $1.6 trillion. These are now defaulting at unprecedented rates, accounting for both their 2008 insolvency and their growing losses today. Since 2008, under government control, the two agencies have continued to buy dicey mortgages in order to stabilize housing prices.

There is more to this ugly situation. New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.

In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.

An Alt-A mortgage is one in which the quality of the mortgage or the underwriting was deficient; it might lack adequate documentation, have a low or no down payment, or in some other way be more likely than a prime mortgage to default. Fannie and Freddie were also reporting these mortgages as prime, according to Mr. Pinto.

It is easy to see how this misrepresentation was a principal cause of the financial crisis.

But I think the main reason people blamed capitalism was much more basic.  It seemed like capitalism had been at fault.  If there had been a Democratic president when all this occurred, then people would have looked much harder at regulatory failure.  The spotlight would have shown much more brightly on the embarrassing statements made by Congressman Frank.  I live in Frank’s district.  And I can tell you that even his hometown newspaper, the Boston Globe, treated him with kid gloves, arguing that all those mean charges made by Republicans were unfounded.  Why no investigation?  Because we already knew the cause of the fiasco, unbridled capitalism.

And I could go on and on.  In another recent post I pointed out that Germany and Saudi Arabia had trade surpluses nearly as big as China.  But as Robin Hanson recently observed, people have already decided that China is a villain, so there is no need to look closely at those other countries.  Now we simply need to find a model which allows us to blame them.  And since (according to Will Wilkinson) the liquidity trap model allows one to make pretty much whatever claim you like, it was trotted out by Krugman, even though it really isn’t appropriate for scenarios where central banks have the option of inflation targeting.  But that doesn’t matter; people have already made up their minds.


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69 Responses to “I’ve already made up my mind! (Big think, et al)”

  1. Gravatar of Michael Michael
    3. January 2010 at 14:19

    Watching this crisis unfold from Australia has been somewhat strange. We might not have experienced the recession that the US did, but we’re getting the same zeitgeist.

    People seem to think of the US as this incredibly laissez-faire country, nothing but pure capitalism! They obviously needed a more regulated banking system like Australia!

    …Except ours was heavily deregulated a long time ago. I mean, separating commercial and investment banking? Hasn’t happened in my life time. Reading what was contained in the Financial Services Modernization Act is this strange experience where you constantly think “it took that long to get rid of that?!”.

    Yet our banking sector generally held up well.

    So what to conclude? Well obviously we need more regulation. Despite the fact that entry into the banking sector is probably the biggest problem (and lack of competition being perhaps people’s main complaint).

    And a stimulus package consisting mainly of giving anyone who wanted it $1200 of home insulation (reduced from $1600 due to problems with shonky operators) saved the country from ruin.

  2. Gravatar of pushmedia1 pushmedia1
    3. January 2010 at 14:47

    “BTW, as long as output is growing below trend and unemployment keeps rising, I think it is premature to talk about a recovery.”

    Output is growing faster than potential output (as estimated by the CBO). By that measure we’re in recovery. And unemployment is a lagging indicator (and has been forever). While declining unemployment is a sure sign we’re in recovery, its likely that recovery starts before the inflection point in unemployment.

    Are you sure your not enthralled by the “the Fed is still too tight” zeitgeist?

  3. Gravatar of Mark A. Sadowski Mark A. Sadowski
    3. January 2010 at 15:09

    In defense of Mark Zandi I have to say that there is a considerable body of empirical and theoretical research that suggests that discretionary fiscal stimulus works quite well provided you have monetary accomodation. Furthermore I’m reasonably familiar with the econometric models he uses to estimate the effects of the current fiscal stimulus. I have little doubt that it has done what he thinks it has done.

    Where I separate from him, and agree with you, Scott, is that I believe the same degree of stimulus could easily have been delivered by the Federal Reserve with far less political fuss and much greater economic effectiveness. But it also seems clear to me, from various statements by Bernanke and other members of the FOMC, they were, and are, unwilling to do what is necessary to fulfill their dual mandate of stable inflation and full employment. Their focus is entirely on long run inflation expectations with everything else seemingly be damned.

    @Michael,
    I couldn’t pass without acknowleding your comment on Australia’s discretionary fiscal stimulus. It was one of the largest on a percent of GDP basis (and I believe also the earliest) among the G-20, and it is generally credited with Australia having avoiding a recession nevermind a major financial crisis. But I have to wonder why any country would go so far as to choose a large fiscal stimulus over monetary stimulus when there was no evidence of a liquidity trap or, for that matter, in retrospect, even a recession.

    @pushmedia1,
    For the most of the time in which we’ve had monthly unemployment rate data it was in fact a coincident indicator. It has only been a lagging indicator since the last two recessions. This change is the subject of much discussion among macroeconomists.

  4. Gravatar of pushmedia1 pushmedia1
    3. January 2010 at 15:26

    Mark, no doubt. It would be strange, then, to wait for a reduction in the unemployment rate to declare a recovery.

  5. Gravatar of q q
    3. January 2010 at 16:57

    have you made up your mind that the subprime fiasco was caused by fannie and freddie? have you looked at the situation broadly, or or you just looking at the opinion papers?

  6. Gravatar of Don the libertarian Democrat Don the libertarian Democrat
    3. January 2010 at 16:58

    I’m a bit puzzled by the view that a Reinforcing Stimulus to QE doesn’t work and isn’t working. This is a post from today in the FT:

    http://www.ft.com/cms/s/0/e188efaa-f8a4-11de-beb8-00144feab49a.html

    “Annexed to the fear that public debt is out of control is the threat – seen by more than a third of economists surveyed – of an inflationary surge. The chief worries are that quantitative easing itself could spur sharp price rises, or that booming recoveries in China and India would do little to help Britain’s meagre exports but would drive up commodity prices. “Over the next few months it is highly likely that we get an intensifying ‘inflation scare’ if growth surprises on the upside,” said former MPC member Sushil Wadhwani.”

    I can’t tell you how many posts like this that I’ve read. So, some people are afraid that govt debt will lead to inflation down the road. That’s what I want, and it’s clearly happening. I simply would like a little more fear. It’s the Stimulus, Govt Borrowing, that is contributing to this fear. Isn’t that how it’s supposed to work? Bring on the fear!

    That will lead people to shift their investments to buying riskier assets like corporate bonds, which are loans to businesses, stocks, and so on. I don’t see how anyone can deny the evidence that many people connect govt borrowing with inflation, and so, for people who desire that, what makes sense is to increase QE and the Reinforcing Stimulus to generate more fear of inflation down the road given my views.

    I can, of course, understand people disagreeing with my views. But there is some evidence that they are working and could work even better.

  7. Gravatar of thruth thruth
    3. January 2010 at 17:02

    I cringe I bit every time I see Pete Wallison being cited so enthusiastically. You only have to look at Fannie and Freddie’s financial statements to see that whatever you call the stuff they are holding, it is nowhere near the low quality junk floating around elsewhere. His count of F/F exposure to subprime and Alt-A seems to be off by at least a factor of two. Moreover, the stuff they openly declare Alt-A is performing twice as well as the Alt-A stuff they don’t own. Most of F/F troubles stem from a familiar cause: not enough NGDP.

    That said, the US system is chock full of dumb regulatory rules and structures (including the GSEs) that seem to encourage excess risk taking at the margin to the detriment of the system. In my opinion, that’s where the real regulatory failure is.

  8. Gravatar of q q
    3. January 2010 at 17:21

    in any case, i just looked through the fannie mae 10-qs from the second and third quarters of 2008 and couldn’t find any admission of such. the conventional mortgage book (ie exclusive of subprime and alt-a) had in both cases 8% of its book in mortgages with FICO < 660 (3% lower than 620). i don't know for sure, but these must have been FICOs at origination because borrower FICOs aren't tracked over time.

    they are long documents though, at 200+ pages each, and it's possible i missed something.

  9. Gravatar of Doc Merlin Doc Merlin
    3. January 2010 at 17:49

    @Michael:
    Why does everyone say we need more regulation when the countries with the least banking regulation (Canada, Australia, etc) were the ones who held up the best under the crisis.

  10. Gravatar of JTapp JTapp
    3. January 2010 at 18:17

    “Furthermore I’m reasonably familiar with the econometric models he uses to estimate the effects of the current fiscal stimulus. I have little doubt that it has done what he thinks it has done.”

    That’s what grad students with econ degrees from B-schools do when they graduate: econometrics and forecasting. Moody’s, Global Insight, etc. they’re not interested in academic theory (or history) but rather putting variables into equations and fitting the curves. Nassim Taleb has written volumes of criticism on this.

  11. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. January 2010 at 18:27

    In Wallison’s most recent piece he’s saying that the FMs were deliberately mislabeling what they were holding. If so their filings would be useless.

    Wallison isn’t a johnny come lately on this, he’s been after the GSEs for years. He did Q&A with Brian Lamb in Sept. 2008, you can either read the transcript or view the program here:

    http://www.qanda.org/Program/?ProgramID=1197

  12. Gravatar of Michael Michael
    3. January 2010 at 19:49

    @Mark,
    Off the top of my head, I can think of a few reasons. The first is simply that we were in a position where we could afford a very large stimulus package – the previous government had been running surpluses for years.

    Secondly, the Labor party had just spent 12 years in the wilderness because of a perceived mismanagement of the economy back in the early ’90s. I imagine they were pretty desperate not to have a recssion, they probably wanted to try everything they could.

    It is a bit crazy that the fiscal stimulus money is still being spent, but we’ve been raising interest rates for months.

    @Doc Merlin,
    Wish I knew. I wonder how the housing regulations compare as well.

  13. Gravatar of thruth thruth
    3. January 2010 at 21:04

    Patrick R. Sullivan said “In Wallison’s most recent piece he’s saying that the FMs were deliberately mislabeling what they were holding. If so their filings would be useless.”

    Only if you believe they are lying about their delinquency and loss rates too. It doesn’t matter what the stuff is called (subprime and Alt-A are merely industry branding anyway), their book is clearly much better than the rest of the industry’s. Their problem was too little capital and an almighty housing bust.

    I realize Wallison’s been after them for years, he obviously can’t resist the urge to stick the boot in now.

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. January 2010 at 21:08

    ‘But I think the main reason people blamed capitalism was much more basic. It seemed like capitalism had been at fault.’

    Since you mentioned that you appreciated Musil’s ‘The Man Without Qualities’, Scott, you might reread the opening pages of chapter one; the part about how someone in the crowd stopped at a traffic accident, says something like, ‘The braking distances of these heavy lorries….’

    I’m operating on memories thirty years old, but iirc Musil understood the power of a simple, understandable, comforting explanation.

  15. Gravatar of B. McVey B. McVey
    4. January 2010 at 03:33

    I think partisanship definitely played a role in labeling who was at fault. With an already unpopular Republican in the White House, it was readily acceptable to argue that another supposed platform of the Republican party had been a disaster. Criticism of “Bush era deregulation” was followed by little substantive commentary about what kind of deregulation there was. It was an easy talking point that people could grab onto. To be honest, Bush really didn’t deserve the benefit of the doubt by that point. Our politics are very emotional; gut reactions stick better than well thought out ones.

  16. Gravatar of ssumner ssumner
    4. January 2010 at 06:19

    Michael, I agree.

    pushmedia1, Output grew 2.2% in the 3rd quarter, what is the estimated trend rate?

    In 1983-84, the last recovery from a deep recession, the economy grew at 6% to 8% for about 6 quarters.

    And yes, I think the economy would benefit from more monetary stimulus and less fiscal stimulus.

    Mark, You said;

    “In defense of Mark Zandi I have to say that there is a considerable body of empirical and theoretical research that suggests that discretionary fiscal stimulus works quite well provided you have monetary accomodation. Furthermore I’m reasonably familiar with the econometric models he uses to estimate the effects of the current fiscal stimulus. I have little doubt that it has done what he thinks it has done.”

    First of all I never denied what you say here. My point wasn’t that fiscal policy could not have stimulated the economy, but the the reasons he gave were not evidence for that stimulus. He talked of huge car and house purchase subsidies leading to more car and house purchases. That’s not evidence that AD rose. That would happen even if the stimulus failed.

    Second, the models that you refer to assume that the central bank is not targeting inflation (or NGDP). But most central banks seem have at least some form of inflation target, even if very loose. If a central bank targets inflation, then the multiplier is zero. So the theory is not really very useful. Regarding empirical studies, people find pretty much what they want to find.

    BTW, I think it much more likely that Australia’s performance was due to an aggressive monetary stimulus, which kept them out of the liquidity trap. Was Australia’s fiscal stimulus as a share of GDP significantly larger than Britain’s? I say that because Britain’s fiscal stimulus didn’t work. I don’t know the size of Britain’s fiscal stimulus, but their deficit in 2009 is 14.5% of GDP. Australia’s deficit is 3.6% of GDP. Yes, this also includes the cyclcial component, which is obviously much larger in Britain. Still, for the fiscal theory to hold in Australia its stimulus package would have to be much larger than Britain’s. I find that hard to imagine.

    I agree with you about unemployment only recently becoming a lagging indicator. And the reason is clear, the last two recoveries have been slower than normal.

    Pushmedia1, I consider a recovery to occur when the economy is beginning to catch up to trend RGDP, not falling further and further behind. If over the next 10 years the economy grew at a steady 2%, and trend was 3%, and unemployment rose steadily to 20%, would that be a recovery?

    q, I pride myself on not making up my mind. My initial hypothesis that it was the fault of capitalism was tentative, so is my current hypothesis blaming the government. The purpose of this comment section is for people to correct the data that I cite. I hope people will do so.

    Doc Merlin, I wondered about that too.

    Don the Libertarian democrat, You said;

    “I’m a bit puzzled by the view that a Reinforcing Stimulus to QE doesn’t work and isn’t working. This is a post from today in the FT:”

    I am not sure who you are referring to, but I certainly never said a reinforcing fiscal stimulus could not work. I happen to think that fiscal stimulus is fairly weak, and that monetary policy is likely to be less stimulative if deficits are increased, but I certainly never suggested that more fiscal stimulus on top of monetary stimulus could not boost AD.

    In my view it would be better to have more inflation in the next few years, and less over the very long term. Right now expectations show inflation much too low over the next few years and a bit too high long term. That’s one reason why I prefer monetary stimulus—I agree with you that big deficits can slightly raise long term inflation forecasts because of fears of monetization of the debt, (although personally I feel that monetization is rather unlikely.)

    Thruth; You said;

    “I cringe I bit every time I see Pete Wallison being cited so enthusiastically. You only have to look at Fannie and Freddie’s financial statements to see that whatever you call the stuff they are holding, it is nowhere near the low quality junk floating around elsewhere.”

    A few comments.

    1. I am not qualified to address your comment directly.
    2. I think he claimed the statements were misleading.
    3. I notice that the TARP loans to private banks are being repaind quickly (I believe less that $100 billion of TARP loans to commercial banks are still outstanding) But the Obama adminstration recently raised the $400 billion credit line to F&F to infinity. That suggests to me that there is a growing awareness in the Obama adminstration that the F&F problems are bigger than expected.

    you said;

    “Most of F/F troubles stem from a familiar cause: not enough NGDP.”

    Yes, this is one of the main arguments of my blog. And not only most of their problems, but most problems at commercial banks are also due to the falling NGDP.

    q#2, See my answer to thruth.

    JTapp, Yes, I am also not a fan of those econometric models. The market forecasts are probably the best we have.

    Thanks Patrick.

    Michael#2, you said;

    “It is a bit crazy that the fiscal stimulus money is still being spent, but we’ve been raising interest rates for months.”

    That sort of craziness will be coming here soon.

    Patrick, I hope to reread Musil some day, but with my blog it’s hard to find time. He was certainly a very astute observer of how people think.

    B McVey, I completely agree.

  17. Gravatar of StatsGuy StatsGuy
    4. January 2010 at 06:38

    Regarding Fannie/Freddie loan quality, observe their long term delinquency rates:

    http://2.bp.blogspot.com/_9ZzZquaXrR8/SsPdVOtQRfI/AAAAAAAAE4A/9W0ZxCBkJMo/s640/FannieMaeDelinquency.gif

    If, indeed, they were buying sooo many “bad” loans back in 1993, why were they continuing to run very low delinquency rates right up till mid-2008 – well _after_ the recession began AND rates began to skyrocket (which was late 2007).

    And, indeed, if you look back at the 2001/2002 recession (coming out of the “profligate” Clinton years), delinquency rates actually DIPPED. If they held such an abysmal portfolio that whole time (from 1993 on), wouldn’t you have expected a huge surge in delinquencies in 2001/2002?

    All of this suggests a particular direction of causation, and that does not run from Fannie/Freddie to NGDP. The ultimate source seems to be the Fed’s failure to live up to its own long term expectations.

    ssumner:

    “But the Obama adminstration recently raised the $400 billion credit line to F&F to infinity.”

    Team Obama is using Fannie/Freddie as a mechanism for absorbing bad debt; They continue to buy mortgages like mad right now, and deliberately so. Housing MBS have become _the_ primary mechanism for pumping money into the system. Fed purchases of MBS outstrip the direct ‘QE’ (300 billion) by a factor of more than 4.

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. January 2010 at 08:51

    ‘If, indeed, they were buying sooo many “bad” loans back in 1993, why were they continuing to run very low delinquency rates right up till mid-2008….’

    Well, the FMs were not buying any in 1993, they came late to the party.

    But, the reason there were few defaults in the late 90s and early oughts is that the bubble kept jacking up prices so you could get out of a mortgage by selling the house at a profit.

    No need to default, until 2006 when prices stopped rising. As Stan Liebowitz found:

    http://johnrlott.tripod.com/Liebowitz_Housing.pdf

    It was at that time that the big increase in defaults came, and the culprit was in adjustable rate mortgages. I.e. the kind of mortgage favored by house flippers (aka speculators)

    The causation runs something like: The CRA of the late 70s, the Boston Fed’s promoting Alicia Munnell’s paper accusing Boston area lenders of racial discrimination in the early 90s, Andrew Cuomo’s HUD’s enthusiastic approval during the Clinton Admin., the FMs jumping on the bandwagon and adding their imprimatur to the game, banking regulators and the Justice Dept threatening lenders who weren’t going along, the low interest rates coming out of the 2001 recession, Barney Frank’s protection of his boyfriend’s GSE by scuttling Bush Admin. attempts to regulate the FMS, until the housing bubble popped.

  19. Gravatar of pushmedia1 pushmedia1
    4. January 2010 at 11:38

    The CBO has potential GDP growing at 2% a year for the next couple of years. I’m not sure how they calculate that estimate..

  20. Gravatar of thruth thruth
    4. January 2010 at 12:05

    Statsguy pretty much nailed it, but I’ll follow up with a few additional points:

    Scott said “2. I think he claimed the statements were misleading.”

    Yes and they have had accounting scandals in the past. But I don’t believe they are lying about their mortgage performance statistics and that’s available in their financial statements.

    “3. I notice that the TARP loans to private banks are being repaind quickly (I believe less that $100 billion of TARP loans to commercial banks are still outstanding) But the Obama adminstration recently raised the $400 billion credit line to F&F to infinity.”

    As Statsguy said, thanks to Paulson’s bazooka, the GSEs are very powerful policy instruments. If Treasury didn’t amend the agreements by Dec 31, 2009 they would be limited to the $400 billion in place. Why give up a free option? This probably wasn’t what the Congress had in mind when they wrote the law and they certainly seemed to learn their lesson when it came to TARP (not that it necessarily improved the bill). I’d be paying back my TARP loan too if my compensation depended on it.

    “That suggests to me that there is a growing awareness in the Obama adminstration that the F&F problems are bigger than expected.”

    That’s certainly true, but F&F never had much capital relative to their peers by virtue of their privileged status. Thus, even if the loans they hold are much less risky, the losses might look worse because they are much more leveraged.

    Patrick R. Sullivan said “But, the reason there were few defaults in the late 90s and early oughts is that the bubble kept jacking up prices so you could get out of a mortgage by selling the house at a profit. … No need to default, until 2006 when prices stopped rising. ”

    Lets look at some data from the MBA National Delinquency Survey (though not perfect is probably the most reliable and comprehensive survey).

    Average Quarterly Foreclosure Start Rate 1998 – 2005
    Prime 0.19%
    FHA 0.76%
    Subprime 1.81%

    Risky mortgages are more likely to default, with or without nationwide price declines. So the claim that F/F held enormous amounts of Junk doesn’t really hold up because F/F’s foreclosure experience looked much more like prime than subprime.

    One of the contributing factors in making the GSEs foreclosure experience much worse in this bust than in the past is the increased is the increased prevalence of second mortgages. The presence of a second lien increases the riskiness of the second lien. The fact that the GSEs weren’t and still aren’t tracking second liens was/is a big mistake.

    “The causation runs something like: The CRA of the late 70s, the Boston Fed’s promoting Alicia Munnell’s paper accusing Boston area lenders of racial discrimination in the early 90s, Andrew Cuomo’s HUD’s enthusiastic approval during the Clinton Admin., the FMs jumping on the bandwagon and adding their imprimatur to the game, banking regulators and the Justice Dept threatening lenders who weren’t going along, the low interest rates coming out of the 2001 recession, Barney Frank’s protection of his boyfriend’s GSE by scuttling Bush Admin. attempts to regulate the FMS, until the housing bubble popped.”

    A more nuanced argument against the F&F would attack the housing policy house of cards as a whole:

    1. The mortgage interest deduction subsidizes home equity extraction. Couple that with very limited recourse to the homeowners other assets in the event of default and we have a very potent recipe for disaster.
    2. FHA and F&F compete against private underwriters with an unfair advantage: their federal backing allows them to underprice their insurance. This encouraged the private underwriters to look for other ways to compete… e.g. offering loans that are attractive to borrower but don’t meet the FHA/F&F criteria (larger loans == more house).

    Replace this nonsense with a very simple first home buyer and/or primary residence subsidy and I doubt we would have a “subprime” fiasco at all. (But then what are all the lawyers and investment bankers going to do?). Perhaps one reason lawmakers have favored the mortgage market approach is budget gimmickry: FHA generally reports itself as a money maker in the budget, F&F haven’t appeared in the budget at all (until the conservatorship) whereas a direct subsidy to home owners would show very large cash outlays.

  21. Gravatar of thruth thruth
    4. January 2010 at 12:11

    “Average Quarterly Foreclosure Start Rate 1998 – 2005
    Prime 0.19%
    FHA 0.76%
    Subprime 1.81%

    Risky mortgages are more likely to default, with or without nationwide price declines. So the claim that F/F held enormous amounts of Junk doesn’t really hold up because F/F’s foreclosure experience looked much more like prime than subprime.”

    let me be clearer: F&F experience between 1998 and 2005 was basically the same as prime.

  22. Gravatar of thruth thruth
    4. January 2010 at 12:19

    at the risk of bad manners let me fix this one to:

    “One of the contributing factors in making the GSEs foreclosure experience much worse in this bust than in the past is the increased is the increased prevalence of second mortgages. The presence of a second lien increases the riskiness of the second lien. The fact that the GSEs weren’t and still aren’t tracking second liens was/is a big mistake.”

    should have read

    “One of the contributing factors in making the GSEs foreclosure experience much worse in this bust than in the past is the increased prevalence of second mortgages. The presence of a second lien increases the riskiness of the first lien because the lack of equity increases into the incentive to default. Even though the second lien takes the first losses, the costs of foreclosure are probably still large enough to impose a loss on first lien holders too. The fact that the GSEs weren’t and still aren’t tracking second liens was/is a big mistake.”

  23. Gravatar of Marcus Nunes Marcus Nunes
    4. January 2010 at 14:25

    There´s the beautiful song “When you mind´s made up” by the Irish Glen Hansard & Marketa Irglova from the movie “Once”. But that´s the only good reference I can think of about people who´ve “made up their minds” about the present situation! In fact no one has made up their mind about anything, quite the contrary, their minds wonder all over the place (Krugman is always the best example of a “wondering mind”, depending on whom or what he wants to bash).
    Bernanke is the most important example. Below tidbits from his 1999 article on Japanese Monetary Policy:
    “Among the more important monetary-policy mistakes were 1) the failure
    to tighten policy during 1987-89, despite evidence of growing
    inflationary pressures, a failure that contributed to the development
    of the “bubble economy”; 2) the apparent attempt to “prick” the stock
    market bubble in 1989-91, which helped to induce an asset-price crash;
    and 3) the failure to ease adequately during the 1991-94 period, as
    asset prices, the banking system, and the economy declined
    precipitously”.
    “But I also believe that there is compelling evidence that the
    Japanese economy is also suffering today from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult”.
    “The argument that current monetary policy in Japan is in fact quite accommodative rests largely on the observation that interest rates are at a very low level. I do hope that readers who have gotten this far will be sufficiently familiar with monetary history not to take seriously any such claim based on the level of the nominal
    interest rate. One need only recall that nominal interest rates remained close to zero in many countries throughout the Great Depression, a period of massive monetary contraction and deflationary pressure”.
    And to contradict his recent answer to DeLong´s question (Why haven´t you adopted a 3% inflation target?) Bernake in 1999 regarding Japan wrote:
    “With respect to the issue of inflation targets and BOJ
    credibility, I do not see how credibility can be harmed by
    straightforward and honest dialogue of policymakers with the public.
    In stating an inflation target of, say, 3-4%, the BOJ would be giving the public information about its objectives, and hence the direction in which it will attempt to move the economy”.
    All in all sounds much like SS!

  24. Gravatar of Marcus Nunes Marcus Nunes
    4. January 2010 at 14:27

    The full article by Bernanke can be found at:
    http://people.su.se/~leosven/und/522/Readings/Bernanke.pdf

  25. Gravatar of Marcus Nunes Marcus Nunes
    4. January 2010 at 14:29

    To cap it all, the WSJ reports that:
    Investors were also comforted by Federal Reserve comments from the weekend, when Fed officials played down the idea of lifting its easy-money policy in early 2010. Nevertheless, Chairman Ben Bernanke said the Fed needs to “remain open” to raising rates to avert or pop future asset bubbles (!!!!)

  26. Gravatar of StatsGuy StatsGuy
    4. January 2010 at 14:29

    A quick comment on Patric Sullivan’s narrative (which has become the default narrative of the right wing media).

    1) In spite of the right wing’s eagerness to lay blame of Mr. Frank and his boyfriend, Frank was well-accompanied on the other side of the aisle. Consider the following credible source:

    http://www.foxnews.com/story/0,2933,115279,00.html

    “”We want more people owning their own home in America,” Bush said. His goal is to have 5.5 million minority homeowners in the country by the end of the decade.”

    (Remember the 2004 presidential debates?)

    2) I’ve commented on this before, but it bears repeating – Initial defaults were highly concentrated in California, Arizona, Nevada, and Florida. These were the states with the sharpest rise, and sharpest fall, the highest delinquency rates – and all of these states were heavily affected by 2007. All were marked by high leveraged speculators with small down payments using non-recourse loans. (Wow… talking about moral hazard…)

    Note MANY states with high minority concentrations – the deep south, for example – with low default rates in August 2008 (right before the Fed blew it badly).

    http://www.vdare.com/images/092808_ss1.jpg

  27. Gravatar of StatsGuy StatsGuy
    4. January 2010 at 14:31

    [part 2 – links keep triggering filters]

    The Bad Four states collapsed WELL BEFORE the crisis spread to the rest of the economy. Banks exposed to these states suffered early and disproportionately. Indeed, F&F delinquencies were extremely low up through middle of 2008, until well after price collapses in the Bad Four states.

    The Right Wing narrative – it’s the minorities and their boyfriend-loving pro-regulatory congressman – has a difficult time with these facts. Indeed, the large state with the lowest initial defaults also had the most regulation (against cash-out refinancing) and a very high ratio of minorities… and that was Texas. Indeed, if the “minorities and congressional boyfriend” narrative was correct, we should observe a STRONGER correlation between default rates and minority presence than we observed in previous recessions (controlling for relevant factors). I haven’t assembled this data, but anecdotally this does not seem true. For instance, Orange County is >78% white…

    http://quickfacts.census.gov/qfd/states/06/06059.html

    … and yet was ground zero for the housing price collapse. Housing prices were already dropping sharply by 2006.

    http://thehousingbubbleblog.com/?p=95

  28. Gravatar of Doc Merlin Doc Merlin
    4. January 2010 at 14:44

    @Michael:
    Housing is odd because housing regs and land use permit requirements vary state to state, coutry to county, and often city to city. Places with frequent natural disasters such as Florida and California tend to have the toughest requirements, iirc. This often leads to large oscillations in housing price in those locations.

    For housing loans, the US has some very schizophrenic regulations. For example, its illegal to discriminate on the basis of the property’s neighborhood.

  29. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. January 2010 at 17:35

    I find the level of intellectual confusion in the comments to this post to be unusually high for The Money Illusion–what relevance is there to the FMs’ COMPARATIVE performance? (though judging by what happened to their stock prices, it was about as bad as it gets)

    Just because some other financial institutions suffered worse losses doesn’t make the FMs blameless. They were PART of a concerted governmental assault on the home lending industry. Without which assault we wouldn’t have had the housing boom and bust. And, we wouldn’t have suffered the catastrophic recession. Anyone seriously disagree with that?

    Anyone disagree that ground zero in the assault on the home lending industry was Boston? That it relied on bogus claims of ‘redlining’ and racial discrimination given surface academic respectability by a Boston Fed paper that was later blown out of the water by Ted Day and Stan Liebowitz?

    Anyone disagree that organizations such as ACORN used the subsequent CRA to extort money from the lending industry?

    Did Barney Frank actually protect his boyfriend’s employer from scrutiny? (btw, I agree that both Republicans and Democrats were involved, but Frank seems to me to be egregiously culpable)

    Maybe we should take a look at the title to this blog post, because it seems some are ironically endorsing it.

    Also, Tom Sowell does a very good job in his ‘The Housing Boom and Bust’ on the special case of California:

    http://www.amazon.com/gp/product/B0028P9BDC/ref=pd_lpo_k2_dp_sr_1?pf_rd_p=486539851&pf_rd_s=lpo-top-stripe-1&pf_rd_t=201&pf_rd_i=0465018807&pf_rd_m=ATVPDKIKX0DER&pf_rd_r=1Y3P575WGQQ2M4Z8NGMS

    In a nutshell, areas with severe restrictions on land use, such as coastal California, had much higher increases in housing costs, and thus had more opportunities for speculators…and more opportunities for spectacular failures.

  30. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. January 2010 at 18:33

    Scott,
    First, I agree with you on the C4C and FTHB subsidies. They are just pushing purchases foreward and I have argued strenuously against both on other weblogs. However I still agree with his estimate of the fiscal stimulus’ overall effect so far.

    Second, if the Federal Reserve is targeting inflation in the short to medium term then they are obviously doing a terrible job. It appears to me that are merely targeting short term interest rates and that the QE they have done is purely window dressing. In that case fiscal stimulus should behave precisely as though the Federal Reserve is targeting a fixed short term interest rate (0% obviously) in which case what the models are telling us should be true. Furthermore I’m an empiricist, so you have just hurt my feelings (just kidding).

    Third, the UK’s discretionary fiscal stimulus was about 1.5% of GDP in 2009. Australia’s was about 2.2% in 2009. Preliminary econometric analysis suggests that the Australian stimulus actually provided somewhat less bang for the buck, almost certainly because monetary policy was less accomodative. That is a major reason why I questioned why Australia ever really needed one.

  31. Gravatar of StatsGuy StatsGuy
    4. January 2010 at 19:11

    Patrick:

    Unfortunately, none of the evidence you present above is new – it lists a set of well hashed conservative talking points. When I first read through the evidence, I agreed it accounted for some part of the crisis. Some modest part.

    But the primary causal factor? There are too many inconsistent pieces of data…

    Even if one accepts Sowell’s argument of land use laws/coastal areas for California, how does that explain Las Vegas? Or vast areas of Florida? Or Phoenix? Why did Hawaii, New York, and Boston – all of which have heavy land use zoning – not experience crashes of similar magnitude? How is this not orthogonal to racial composition of states? Why did the bubble hit in so many high income areas, instead of the low income areas with subsidized housing where Federal programs are most aggressive? How could Frank be so responsible when the bubble manifested in 2003-2006, when he was not even chair of his committee? Surely, the then-dominant chairmain could have acted…

    Yet Barney Frank – a single Congressman out of 435 in a Congress that can barely pass anything, plays the dominant role in the conservative narrative.

    In any case, here is Frank’s own response to several of your accusations:

    http://www.huffingtonpost.com/rep-barney-frank/wall-street-journal-edito_b_150350.html

    I should like to see your point-by-point response to his rebuttal. Then I should like to see how Frank’s immense personal authority and incredible oratorical skills (the sources of his immense influence) swamped the other factors that drove the crisis, such as:

    Massive principal agent problems in ratings agencies
    Development and popularization of CDO structures & traunching
    Bad math mistakes
    Weak enforcement of capital asset ratios
    Poor compensation structures in finance
    Greenspan
    Excess political power of TBTF institutions
    Poor tax structures related to mortgage debt
    Financial deregulation
    Low savings rate, excess consumption, and cash-out refis
    etc.

  32. Gravatar of Greg Ransom Greg Ransom
    4. January 2010 at 21:59

    I’m actually shocked you didn’t know this about Freddie and Fannie.

    You should also know that Posner insists his book title doesn’t reflect the content of his book (see Posner’s EconTalk interview).

    Besides some graphs and a bit of government and Fed macro data, what HAVE you read or studies about the financial crisis, the housing disaster, etc. ?

  33. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. January 2010 at 22:01

    Stats Guy, as I expected, you completely failed to answer my specific questions. Instead, you changed the subject.

  34. Gravatar of Simon K Simon K
    5. January 2010 at 02:03

    Patrick, I’m not really sure what your specific points are. Maybe Statsguy isn’t either. I can’t really comment on Barney Frank, his boyfriend, the CRE, the GSE, ACORN, the Boston Fed, or whatever else was involved in the conspiracy against private home lending that you seem to believe existed. The US mortgage market is wildly distorted by many things, but I can’t see how these things led specifically to a property boom focused specifically in the South West and funded largely by private capital. Perhaps you can explain the transmission mechanism?

    What I would say, as I’ve said here before, is that Liebowitz paper is flawed. His graphs that purport to show that the problem was ARMs and not sub-prime omit the huge increase in the volume of sub-prime lending, so the relatively large number of sub-prime foreclosures in 2006 (roughly 0.3% of all mortgages) looks smaller than the MUCH smaller number in 2000 (only 0.06% of total mortgages). Its odd to choose a presentation that not only doesn’t quite show what we’re really interested in (we want to know the number and concentration of sub-prime defaults, not the performance of sub-prime loans as an investment) but simultaneously makes numbers that are actually bigger look smaller. Add to that the fact that almost all sub-prime loans are ARMs, and the core of his case looks rather shaky. If you want a good blame-the-government story, I suggest Arnold Kling’s.

    On the subject of ARMs, I have a pet peeve here. Its very odd when people talk about adjustable rate mortgages as if they were some kind of arcane monstrosity only a speculator could love. Throughout space and time some kind of adjustable rate loan (or short term balloon) has accounted for the vast bulk of mortgage lending and fixed rates are the oddity. The 30 year fixed rate loan everyone seems to believe is the epitome of financial prudence is actually a peculiarly American creation of government regulation – without the GSEs it simply would not exist.

    The thing with ARMs isn’t that there’s anything specifically wrong with the idea – neither the buyer, who’ll probably only stay in the house for 7 years, nor the lender, who doesn’t want the interest rate risk, really wants a deal with 30 years of interest rate protection built in. Conventional hybrid ARMs are about as harmful as apple pie – the lender offers a lower rate (not discounted – it still includes the full risk premium) because he carries marginally more default risk in exchange for much less interest rate risk. If the default risk was really that elevated, this wouldn’t work (another reason to be suspicious of Liebowitz’s argument).

    The problem comes when the lender offers not just a lower rate but a discounted rate. ie. The initial monthly payments do not include enough interest to account for the default risk. Why would that happen? Basically because the risk premium is too high for the borrower to pay, so the lender “structures” a product where he can pay less monthly in exchange for charges elsewhere. This is more-or-less the operational definition of a sub-prime loan. Since the borrower can’t pay points or an insurance premium up-front, the charges are shuffled off into the future. There are several ways this can be done, but they all amount to the same thing – at some point the loan “resets” not to the index plus some sensible risk premium like a well behaved conventional hybrid ARM, but to some astronomically high interest rate, intended to now pay the lender the risk premium forgone in the first 2 (its usually 2) years.

    Now of course the borrower can’t afford that (usually) so they have to refinance. Which is just fine by the lender – that was really the idea. How does the lender recover the risk premium in this case? Through a redemption penalty – essentially a percentage of the amount borrowed that must be repayed in bulk if the loan is redeemed before the discount is repayed. Again there a few other ways this can be done, but they all amount to the same thing – no charges up front, low initial monthly payment, forced refinance through dramatic payment increase, and a proportion of the funds from the refinance or sale goes back to the lender.

    This all works just fine until house prices start to drop, and I’m actually not sure (call me insane if you like) that its even a bad idea, but its a totally different thing from a conventional hybrid ARM and you shouldn’t conflate the two when considering default rates.

  35. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. January 2010 at 09:26

    Simon K, you’ve outdone Stats Guy in changing the subject.

    Btw, why would you need me to ‘explain the transmission mechanism’? If you’ve read the Liebowitz paper you already have the explanation.

    When people go to such lengths to avoid responding to specific questions, I know they know they’ve lost the argument.

  36. Gravatar of StatsGuy StatsGuy
    5. January 2010 at 12:29

    It’s not that we disagree with the facts. Certainly Barney Frank has a boyfriend, and Frank showed favoritism to him, etc. We simply disagree that those facts were the major causal factors in the crisis, as your narrative maintains. We have tried to explain why, and your response has been to disregard a mountain of citations and facts with a simple wave of your hand.

    We have made a good faith effort to present a detailed case and back it up. Your response is the blogging equivalent of declaring victory:

    http://images.chron.com/blogs/txpotomac/mission_accomplished.jpg

  37. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. January 2010 at 15:33

    Stats Guy, you ducked the four specific questions I asked, which were (so you don’t have to scroll up):

    ———–quote————
    [1] Just because some other financial institutions suffered worse losses doesn’t make the FMs blameless. They were PART of a concerted governmental assault on the home lending industry. Without which assault we wouldn’t have had the housing boom and bust. And, we wouldn’t have suffered the catastrophic recession. Anyone seriously disagree with that?

    [2] Anyone disagree that ground zero in the assault on the home lending industry was Boston? That it relied on bogus claims of ‘redlining’ and racial discrimination given surface academic respectability by a Boston Fed paper that was later blown out of the water by Ted Day and Stan Liebowitz?

    [3] Anyone disagree that organizations such as ACORN used the subsequent CRA to extort money from the lending industry?

    [4] Did Barney Frank actually protect his boyfriend’s employer from scrutiny? (btw, I agree that both Republicans and Democrats were involved, but Frank seems to me to be egregiously culpable)
    ————-endquote————

    Until now, when you concede #4. Care to demonstrate your good faith by answering the other three?

  38. Gravatar of StatsGuy StatsGuy
    5. January 2010 at 16:34

    1) I have seen little evidence of a “concerted assault”, implying some sort of leftist conspiracy. But if you mean that there was a faction pushing for expansion of federal programs to minorities, certainly yes.

    “Without which assault we wouldn’t have had the housing boom and bust.”

    I “seriously disagree” with that – there were many other factors and actors, of which this was not the most important. Moreover, it’s quite likely that the absence of any one or two major factors could have mitigated much of the housing crisis, even in the presence of the others. In this sense, singling out any one causal factor as _the_ story is arbitrary. The absence of Barney Frank would likely have mitigated the crisis slightly, but not as much as the absence of many (all?) of the other factors listed above.

    2) Yes, I disagree – and I cited plenty of evidence; if your hypothesis is correct (the problem was expanion of eligibility to minorities with poor loan performance characteristics), then we should see evidence of a link (this bubble should hit minorities proportionately more than past bubbles). Look at the charts above. Where is it?

    Or is your hypothesis that the problem was the general weakening of lending standards across the board (to which Frank was just as complicit as many other politicians, including Bush and the Republican Congressional leadership)? But then, how does the purposeful extension of loans to minorities (mostly poorer) in places like Toledo and Montgomery cause a speculative bubble which hits hardest in white, affluent communities in the four states listed?

    3) How is this a “causal factor”? Are you seriously arguing that if ACORN had not “extorted” money, the housing bubble would not have occurred?

    4) I don’t know the sordid details of this one as well as you, I’m sure. So file this under “don’t know”. Or, perhaps, don’t care. Are you seriously arguing that if Frank had not protected his boyfriend, the housing bubble would not have occurred?

    I’m baffled at how one bumbling congressman takes the role of central villain in this tale.

    Now, as to the other half a dozen factors –

    Massive principal agent problems in ratings agencies
    Development and popularization of CDO structures & traunching
    Bad math mistakes
    Weak enforcement of capital asset ratios
    Poor compensation structures in finance
    Greenspan
    Excess political power of TBTF institutions
    Poor tax structures related to mortgage debt
    Financial deregulation
    Low savings rate, excess consumption, and cash-out refis

    Perhaps you could point-by-point isolate which of these factors you think are less important than Barney Frank, and (briefly) why? Could you also answer Frank’s response to the accusations?

    I dislike Frank considerably, for many reasons, but painting him as the poster child villain of the housing bubble reminds me of Soviet style propaganda.

  39. Gravatar of Simon K Simon K
    5. January 2010 at 18:10

    Patrick, I’m not sure really what you think think you specifically want answers to. You asked a bunch of rhetorical questions up-thread about ACORN, Barney Frank, the Boston Fed and so on and so forth up-thread, but I’m sure you already have answers to those that you’re happy with. Personally I don’t care what the answers are – it doesn’t seem to signify one way or the other who Barney Frank was dating, what happened in Boston, or what the government tried to get the poor defenseless mortgage servicers to do, since none of these things is even potentially an interesting partial explanation of the crisis. I’m not changing the subject but trying to explain why Liebowitz’s explanation, which you seem to be embracing, doesn’t even pass the sniff test.

    Liebowitz claims to show that the underlying cause of the crisis is government regulation, a point I partially agree with, but his specific argument is weak. He claims that without government intervention in lending standards, the huge increase in mortgage lending, accompanied by declining underwriting standards would not have happened, but he apparently also wants to hold the sub-prime mortgage brokers, servicers, aggregators and bond holders who did the actual lending at those low lending standards blameless. Its hard to see how anyone could square this circle – apparently all those bankers had to be forced at gun-point into making vast wads of cash because they really wanted to be responsible even though there was no downside for them. Or something.

    So what he actually ends up doing is spending the first, least interesting, part of the paper rambling about how the government wanted lower lending standards (which is true but not interesting since everyone at that time wanted lower lending standards) and then the second half arguing that lower lending standards can’t have been the problem because sub-prime loans performed just as well as prime and maybe the problem was ARMs after all. What he should have done in the second half is show empirical data demonstrating that the CRA and agency intervention lowered lending standards or at least increased lending volumes, but he doesn’t because no such data exists.

    What he does instead is present a story that is interesting but not true – its not even clear what Liebowitz means when he says sub-prime loans performed just as well as prime, since his own data shows them having vastly higher default rates. What I think he means is that the graphs he shows are kind of the same shape, but this is misleading – sub-prime defaults start to grow in mid-2004, well before prime defaults and from a much higher initial level. When you consider that the volume of sub-prime lending also rose from 2% to about 13.5% between 2000 and 2006, its clear that in fact sub-prime defaults are accelerating in absolute terms from a much earlier date that prime. Its just that Liebowitz’s presentation of the data hides this fact. His ARM vs fixed rate data is also rather misleading – fixed rate sub-prime loans are almost non-existent and were not a growing market. Almost all sub-prime loans are ARMs of the toxic variety I described previously, which are very different in their response to house prices than most prime ARMs (there are prime ARMs with large payment shocks and back end charges and I’m not exactly sure what Liebowitz included in his prime ARM data-set).

    So we’re left with the fact that sub-prime loans do in fact default more than prime loans, and were disproportionately important during the crisis, and that prime ARMs default more than fixed rate loans, but at a lower rate than sub-prime. Once you strip out the misleading presentation, I don’t know why any of this is meant to be surprising, and it certainly doesn’t particularly help his argument that the problems originated with government intervention to lower lending standards – prime ARMs had more or less the same lending standards throughout the period under consideration, and sub-prime obviously means low lending standards because that’s what sub-prime means. At the very least, given the vast profits involved, government intervention seems like an unnecessary detail in the sub-prime story.

    Let me offer you a more realistic story. You’ll like it because it blames regulation, but maybe not as much as Liebowitz’s because it doesn’t follow standard libertarian guidelines in allowing you to blame minorities and feckless speculators or call for the gold standard as the solution to our woes. The US mortgage market is historically extremely conservative and heavily regulated compare with other countries where home-ownership is common. Prior to the early 90s there were regulatory obstacles to offering products with variable rates, or no or negative amortization which are respectively standard and quite common elsewhere. Since fixed rate products aren’t profitable for the lender over very long terms, the government set up aparatus to make sure a secondary market existed for these products and to insure and gaurantee them as necessary. In spite of that, mortgages continued to be expensive and to have high downpayment and credit requirements. As a follow on consequence, house prices were low relative to incomes. But this had benefits – the mortgage lending industry could qualify buyers very easily based simple income ratios and with little cushion to account for price or interest rate fluctuations, and although lenders got sub-par returns, both borrower and lender took very little risk.

    With the removal of the regulatory obstacles in the early 90s, mortgage lenders began to “innovate” in that they reintroduced standard mortgage products they could actually make money from, sometimes without even needing the government to help out. But unfortunately business practices, public perceptions and the regulatory structure did not keep up. Lending decisions continued to be made on the basis of income ratios, so lenders and borrowers collaborated in gaming the system by fiddling either the income part (low-doc, no-doc, alt-doc and so on) or the payment part (discounted initial rates in exchange for back-end payments). Borrowers may or may not have understood what was happening, the the regulatory system and the secondary market most certainly did not. All of this innovation of cause led to a rise in demand and hence in house prices, which in turn led to more demand and more innovation and housing looked like a good investment and everyone happily ignored the risks. The rest is history.

  40. Gravatar of thruth thruth
    5. January 2010 at 18:19

    Patrick:

    [2]-[4] are irrelevant. Was it the first grain of sand or the last that broke the camels back? What are the policy implications?

    I think I already expressed some sympathy for number 1 when I said:

    “1. The mortgage interest deduction subsidizes home equity extraction. Couple that with very limited recourse to the homeowners other assets in the event of default and we have a very potent recipe for disaster.
    2. FHA and F&F compete against private underwriters with an unfair advantage: their federal backing allows them to underprice their insurance. This encouraged the private underwriters to look for other ways to compete… e.g. offering loans that are attractive to borrower but don’t meet the FHA/F&F criteria (larger loans == more house [== more risk]).”

    These obviously aren’t the only problems, but they seem first order to me. I’m not sure I’d describe these problems as an “assault” on the industry. They’re just part of a bad incentive system.

    Moreover, I think that in any modern economy there’s always going to be risks of boom and bust. The current US system just seems to be more prone to large busts because of numerous policy choices that encourage extra risk taking.

  41. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. January 2010 at 19:04

    ‘…if you mean that there was a faction pushing for expansion of federal programs to minorities…’

    I’ve noticed your fixation on ‘minorities’, you seem to be under the impression that politicians sailing under that flag actually have the intentions they declare.

    But, you haven’t seen anything like:

    ———-quote————-
    Congress also passed the Home
    Mortgage Disclosure Act (HMDA) in 1975, which
    required that mortgage lenders provide detailed information
    about mortgage applications. Every year
    banks receive a score on their CRA compliance just
    as they receive a score on their financial viability, and
    banks strive to do well on both parts of their examination.

    In 1991 the HMDA data was expanded, allowing
    for comparison of rejection rates by race. Various
    news organizations started publicizing simple
    examinations of HMDA data, showing that minorities
    were denied home mortgages at a rate far
    higher than that for whites. It was and still is common
    for newspapers in large cities, shortly after the
    yearly HMDA data are made public, to do exposés
    examining the differences by race in rejection rates
    on mortgage applications. There are even turnkey
    kits for newspaper reporters aspiring to demonstrate
    such results. Although such comparisons are completely
    unable to distinguish between the possibility
    of discrimination or differences in credit worthiness
    as explanations and are therefore fairly meaningless,
    these results were and are trumpeted far and wide in
    the media.

    The last defense of banks trying to defend themselves
    against charges of engaging in biased mortgage
    lending appeared to fall when the Federal Reserve
    Bank of Boston (Boston Fed) conducted an apparently
    careful statistical analysis in 1992, which purported
    to demonstrate that even after controlling for
    important variables associated with creditworthiness,
    minorities were found to be denied mortgages
    at higher rates than whites.

    In fact, the study was based on such horribly
    mangled data that the study’s authors apparently
    never bothered to examine them.
    ———endquote———-

    You weren’t aware that, ‘Within a few months of the appearance of the Boston Fed study, a new manual appeared from the Boston Fed. It was in the nature of a “Nondiscriminatory Mortgage Lending for Dummies”…booklet.’

    That in that pamphlet the president of the Boston Fed wrote:

    ‘Did You Know? Failure to comply with the
    Equal Credit Opportunity Act or Regulation B
    can subject a financial institution to civil liability
    for actual and punitive damages in individual
    or class actions. Liability for punitive damages
    can be as much as $10,000 in individual
    actions and the lesser of $500,000 or 1 percent
    of the creditor’s net worth in class actions.’

    Doesn’t that sound like a threat? And how about this howler from the same pamphlet:

    ‘Even the most determined lending institution
    will have difficulty cultivating business from
    minority customers if its underwriting standards
    contain arbitrary or unreasonable measures
    of creditworthiness.’

    As the man from whom I’m borrowing it, put it, wouldn’t it be difficult to cultivate business from ANYONE if you have ‘arbitrary or unreasonable’ standards?

    The pamphlet goes on:

    ‘Management should be directed to review existing
    underwriting standards and practices to
    ensure that they are valid predictors of risk.
    Special care should be taken to ensure that
    standards are appropriate to the economic
    culture of urban, lower-income, and nontraditional
    consumers.’

    Again, that sounds like…oh…the beginings of ‘a concerted assault’, does it not?

    That’s all I have time for now, but I’ll try to add more tomorrow. Since you’re so interested.

  42. Gravatar of scott sumner scott sumner
    5. January 2010 at 19:42

    statsguy, I agree that there weren’t big problems in 1993. Any mortgage taken out in 1993 had positive equity, and house prices were rising. Even an unemployed person would not default, they’d sell the house. For both banks and F&F, almost all the problem mortgages were issued in the 2004-07 period. There weren’t that many houses bought in that short span of time, but a huge number of mortgages were refinanced. That is also the period when F&F got much more aggressive accumulating junk.

    In the last part of your comment I think you are confusing the FED policy of buying MBSs, which is monetary policy, with the Obama administration bailout, which is fiscal policy.

    Patrick, Your analysis is similar to what I recalled. That’s not to say that lots of banks weren’t reckless. Many large banks invested far more in MBS that they were forced to by regulators. But I agree with the basic timeline.

    Pushmedia1, I don’t know either, but my hunch is that the trend rate is slowing a bit, so 2% may be correct.

    thruth; You said;

    “That’s certainly true, but F&F never had much capital relative to their peers by virtue of their privileged status. Thus, even if the loans they hold are much less risky, the losses might look worse because they are much more leveraged.”

    and

    “One of the contributing factors in making the GSEs foreclosure experience much worse in this bust than in the past is the increased is the increased prevalence of second mortgages. The presence of a second lien increases the riskiness of the second lien. The fact that the GSEs weren’t and still aren’t tracking second liens was/is a big mistake.”

    OK, but this is the issue I really care about. I shouldn’t have said they had a lot of junk, obviously I am no expert. The the public policy problem here isn’t the housing bubble, it is the losses that the taxpayers have to absorb. For whatever reason F&F are now a big burden on the taxpayer, and that is a huge public policy concern regardless of the quality of their mortgages.

    I thought the last few paragraphs of suggestions you provided were excellent, but will skip them for lack of time.

    Statsguy, Very good point about the deep south.

    Regarding Frank, I don’t know anything about his boyfriend, but I do recall that somewhere around 2003-05 he stopped the Bush administration from reining in F&F. Yes, there were others, including some Republicans. But in my view he is the person most responsible for the mess F&F got into. And then he denied any culpability and blamed it all on “deregulation,” whatever that means in a country that has more regulations than any other country on earth.

    Bush’s policies were also pro-housing, and I agree that was stupid. If there were specific policy actions by Bush that blew up the sup-prime bubble, let’s criticize him for that. Speeches don’t have much effect.

    Statsguy, Yes, the center of the country did not have much of a bubble. That’s easy to explain because housing is a constant cost industry and so land prices are the key to the coastal bubbles. What I couldn’t understand in 2006 and still don’t understand is Nevada and Arizona. Yes, they have some federal land issues, but still there must be plenty of land available. I didn’t know that about cash out refinancing being banned in Texas. Does that mean the new mortgage can’t be bigger than the old one? Is it enforced? In retrospect it certainly helped.

    Patrick, I was also very suspicious about the discrimnination study. I recall reading that minorities did not have lower default rates than whites. But if they were discriminated against they should have had lower default rates, (as only the best would have gotten mortgages.)

    At the same time Statsguy is right that the sub-prime fiasco was a separate issue to some extent, as it was concentrated more in Hispanic and white areas than African-American areas.

    But I agree that a lot of different Federal policies all played a role. Even after this long thread I still have an open mind on the relative share of blame between the public and private sector.

    Mark, Thanks for the data on Australia. The UK tax system must be pretty dysfunctional if they have a 14.5% of GDP deficit with only 1.5% stimulus! And with the Aussie stimulus at 2.2% (smaller than in the US) it obviously doesn’t explain Australia’s success.

    Your views on fiscal stimulus are certainly defensible. But think about it this way: Do you agree with Krugman that the Fed would have just stood back and allowed a big depression if the Congress had failed to enact stimulus? I don’t.

    Statsguy, I mostly agree with your thoughts on geography, and made similar comments already. but I must take issue with you defense of Frank:

    1. A single Congressmen who chairs a committee, or is even the ranking minority party member, can be very important if the committee is powerful. They can bottle up legislation.

    2. Remember that no one was paying much attention to these issues in 2003. But I vividly remember an article in that right-wing paper the NYT around 2003 that basically said Frank was the key Congressman stopping the Bush administration attempt to rein in the F&F.

    For the broader issues of the overall crisis, yeah, there were lots of factors. Neither Bush, Frank, Greenspan or Bernanke created the subprime fiasco all by themselves. They had lots of helpers.

    Greg; You said;

    “You should also know that Posner insists his book title doesn’t reflect the content of his book (see Posner’s EconTalk interview).”

    But I have read articles written by Posner about the crisis. And he clearly did indicate in those articles that he thought the crisis was a failure of capitalism.

    Simon K, I agree that there is nothing wrong with ARMs per se. It was excessive risk taking with zero down no income verification mortgages. The root causes were moral hazard and government policies like F&F. The moral hazard comes from FDIC and TBTF.

    I’m out of time, and as Greg said it isn’t my area of expertise, so I’ll let you guys fight it out. I am most interested in statsguy telling me more about how the huge losses at F&F are misleading. He may be right, but I don’t quite follow his argument. Maybe someone else can also help educate me.

  43. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. January 2010 at 21:07

    Scott,
    A very deep recession in the UK is leading to reduced revenues just as it is here. Our own deficit is about 11% of GDP and very little of that is discretionary fiscal stimulus. The US fiscal stimulus was actually 2.0% of GDP in 2009. Don’t forget It’s being spent over 3+ years.

    Australia’s success has much more to do with the fact that it was never in as dire straights as the US or the UK.

    As for what the Federal Reserve would have done without a fiscal stimulus, this raises the question as to why the Federal Reserve spoke so glowingly of the idea of a fiscal stimulus when it was first proposed in the fall of 2008. I suspect the answer is absolutely nothing, just as they are doing currently.

  44. Gravatar of StatsGuy StatsGuy
    5. January 2010 at 21:36

    ssumner:

    Projected losses of ~400 billion (huge) over 10 years were realistic back in May. For example:

    http://www.pewtrusts.org/news_room_detail.aspx?id=51586

    In all likelihood, these losses would have decreased (as they have for other banks), except that while other banks cut their purchases of mortgages and mortgage backed securities (and indeed unloaded some), during the past year F&F have consumed a LARGER portion of the MBS market than in prior years. It’s an odd spectacle for bankrupt companies to be buying proportionally more assets; the reason is simple – they are being used as a vehicle to support the housing market. For example:

    http://www.reuters.com/article/idUSTRE55L39120090622

    F&F were compelled to more aggressively modify mortgages than private banks. Indeed, very early in 2009, F&F were compelled to increase (at favorable prices to consumers/other banks) holdings – effectively being used as a tool to absorb losses.

    http://www.washingtonpost.com/wp-dyn/content/article/2009/02/18/AR2009021801467.html

    We can call this fiscal policy (though you know I have difficulty discerning fiscal vs. monetary policy when fiscal action is backed by 1.25 trillion in direct Fed purchases).

    I can’t really assess F&F’s loan quality vs other banks. I’m merely stating that citing as evidence the fact that (some) banks are repaying TARP loans while F&F are needing more money than expected is getting the causation backwards.

    F&F are needing more money precisely because they were absorbed by the government, and are being used as the vehicles of policy action that is heavily favorable to other banks and the housing market in general.

  45. Gravatar of StatsGuy StatsGuy
    5. January 2010 at 21:38

    BTW, when I say I can’t assess F&F’s loan quality, I mean in 2008. The notion that F&F’s loan quality problems extend back to 1993, however, seems far more tenuous for reasons mentioned above.

  46. Gravatar of thruth thruth
    6. January 2010 at 07:50

    Agree with Statsguy on F&F as policy instruments. If F&F weren’t wards of the state, they would have raised fees and cut volume once the crisis picked up. They also wouldn’t be paying for negative NPV mortgage modifications out of pocket.

    Statsguy said “Projected losses of ~400 billion (huge) over 10 years were realistic back in May.”

    The $400bn estimate comes from CBO. That number is based on the fair value of the net negative equity reported by F&F (approx $250bn) plus additional amounts for the estimated underpricing of their guarantees on current and new loans relative to their private sector peers (i.e. projecting loans made through 2019).

    In any case, if you look at Table 1.3 of the IMF’s April 2009 Global Financial Stability report, they were estimating approx $250 bn for the GSEs out of the $800bn in total US mortgage losses, or 30%. Given that the GSEs guaranteed more than 40% of the market, that suggest they are doing better than most of the market.

    Scott Sumner said “The the public policy problem here isn’t the housing bubble, it is the losses that the taxpayers have to absorb.”

    Agree. That’s the nature of the subsidy. Taxpayers pay the price ex post for the subsidy inherent in allowing the GSEs to use their federal backing underprice mortgage insurance ex ante. Put differently, if the GSEs were strictly private entities they would have held much more capital, charged higher fees, which would have provided a bigger cushion against losses. They probably would be much smaller than they are, perhaps merged into the banks altogether.

  47. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    6. January 2010 at 10:06

    Let’s continue with the story of how the Boston Fed got the snowball rolling down the hill. In their infamous pamphlet, we find this advice to lenders:

    ‘Lack of credit history should
    not be seen as a negative factor. Certain cultures
    encourage people to “pay as you go” and
    avoid debt. Willingness to pay debt promptly
    can be determined through review of utility,
    rent, telephone, insurance, and medical bill
    payments. In reviewing past credit problems,
    lenders should be willing to consider extenuating
    circumstances. For lower-income applicants
    in particular, unforeseen expenses can
    have a disproportionate effect on an otherwise
    positive credit record. In these instances, paying
    off past bad debts or establishing a regular
    repayment schedule with creditors may demonstrate
    a willingness and ability to resolve
    debts. Successful participation in credit counseling
    or buyer education programs is another
    way that applicants can demonstrate an ability
    to manage their debts responsibly.’

    Stats Guy, does that sound like sound economics?

    Btw, can you guess what ‘community organization’ was in the business of providing credit counseling?

    Back to the Fed pamphlet:

    ‘Special consideration could
    be given to applicants with relatively high obligation
    ratios who have demonstrated an ability
    to cover high housing expenses in the past.
    Many lower-income households are accustomed
    to allocating a large percentage of their
    income toward rent. While it is important to
    ensure that the borrower is not assuming an
    unreasonable level of debt, it should be noted
    that the secondary market is willing to consider
    ratios above the standard 28/36.’

    Again, this is astoundingly bad economics. Low income people, having less savings to tide them over rough times, are less likely (not more) to be able to handle emergencies. Thus, they are more likely to default.

    Also, that last line about the secondary market is an oblique reference to Fannie Mae being onboard (for those still defending the idea that the FMs weren’t enabling this ‘concerted assault’).

    Back to the Fed:

    ‘Down Payment and Closing Costs: Accumulating
    enough savings to cover the various costs
    associated with a mortgage loan is often a significant
    barrier to home ownership by lower-
    income applicants. Lenders may wish to allow
    gifts, grants, or loans from relatives, nonprofit
    organizations, or municipal agencies to cover
    part of these costs. Cash-on-hand could also
    be an acceptable means of payment if borrowers
    can document its source and demonstrate
    that they normally pay their bills in cash.’

    Which paragraph opened the door to builders ‘gifting’ funds to buyers, which funds being recovered by boosting the price of the house. An invitation to fraud, imho.

    Now for my favorite bit of ‘advice’ from the pamphlet:

    ‘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.’

    Unemployment benefits are TEMPORARY (and presumably so are welfare payments). Stats Guy, would you lend YOUR money to someone who was asking for a thirty year repayment schedule and counting on unemployment benefits to repay you?

    One of the lenders who jumped onto this bandwagon was Countrywide. Presumably I don’t need to detail what happened to them.

    Which is probably a good time–given that even Scott must have some limit to his patience over my use of his bandwidth–to ask again, isn’t it obvious that without the concerted assault I’ve been detailing here, the problem of the housing boom and bust wouldn’t even have arisen? That we probably wouldn’t even have known what business Countrywide was in?

    I don’t see how anyone can deny this and keep a straight face. Unless, as Scott put it ‘I’ve already made up my mind!’

    Also, another financial services firm that bought into the Boston Fed’s advice was Bear Stearns. They adapted the language from the pamphlet to create sales brochures extolling their mortgage backed securities. I guess they won’t make that mistake again.

  48. Gravatar of StatsGuy StatsGuy
    6. January 2010 at 10:43

    Patrick –

    You are essentially repeating the arguments in the Liebowitz paper, which Simon K and Thruth have addressed better than I can. No one is challenging the text in the pamphlet – everyone is challenging that the text (or actions directly resulting from that text) were the primary cause of this crisis.

    Also, you now appear to be explicitly arguing that the problem was loans to minorities (and not a general weakening of lending standards overall). Yet the data shows minimal linkage (if any). Where is your data? Even Liebowitz, after spending half the paper complaining about minorities, then goes on to blame the crisis on something else. It’s like watching a Quentin Tarantino movie – the first half has nothing to do with the second half.

    Nor do we see evidence of actual legal action for failure to abide by these policies… Who was in charge of enforcement in 2003-2006? Bush Administration and Republican oversight committees – were these rules aggressively enforced, or were they treated like various EPA rules that were deliberately not enforced? Where is your evidence that this pamphlet had a massive impact on behavior?

    Nor does your narrative explain why the credit agencies gave these MBS traunches AAA ratings, or why so many middle/upper class white people in exclusive neighborhoods were impacted, or why stockholders of banks who were buying all these minority loans didn’t short sell the banks much earlier, and many many many other dynamics that appear more important.

    Your argument is as follows:

    “The dog barked this morning. Someone died of a heart attack. I assert that the dog’s barking caused the heart attack. Do you or do you not deny that the dog barked?”

    I’m going to politely defer on future commentary regarding this topic. Peace.

  49. Gravatar of StatsGuy StatsGuy
    6. January 2010 at 10:48

    ssumner:

    http://www.refinancingestate.com/cash-out-laws-on-refinancing-in-texas/

    Choice quote: “Laws related to cash out refinancing in Texas sates that loan amount cannot exceed 80% of home’s appraised value.”

    Remember our Refi discussion? My primary suggested ammendment to the Texas rule was to change “appraised value” to base it on a multi-year moving average.

  50. Gravatar of Simon K Simon K
    6. January 2010 at 12:58

    Does anyone have a reference for the “research” by Edward Pinto that the WSJ is citing? I’m no fan of Fannie and Freddie, but something about this doesn’t add up. Mr Pinto doesn’t seem to be a neutral housing expart, but rather a mortgage industry flack who writes for the Wall Street Journal in his own right when not being cited as an “expert”. Previous hits include “Acorn and the housing bubble” and “Yes, the CRA was toxic”, neither of which actually adds anything to the normal poor-innocent-bankers-forced-at-gunpoint-to-make-wads-of-cash talking points.

    The WSJ journal article appears to be playing some numbers games. It gives the prime/sub-prime dividing line as FICO 660, whereas it was usually taken to be 630 until the crisis. although FICO scores aren’t the only determinant. It also conflates sub-prime and Alt-A when giving numbers, defining Alt-A very broadly to include loans with no or low downpaymnet. But usually a low-downpayment loan can be considered prime if the borrower pays for PMI, because at that point it IS prime as far as the holder is concerned.

    He also quietly conflates numbers from 2008 with things that happened “since 1993”. I’m absolutely certain the GSE’s balance sheets have deteriorated since being taken into conservatorship since they’re now being used to bail out the housing market as a whole. The real question is whether they were in worse shape than they claimed in 2006 and thereby contributed to the crisis. I strongly suspect Wallison and Pinto don’t have any data saying they were, because if the did they’d cite it rather than talking about H2-2008. Instead, in the long tradition of proponents of the blame-the-CRA story, they pretend to have data and then cite something different.

  51. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. January 2010 at 13:53

    I used to spend a lot of time debunking the claims of Pinto and Wallison concerning the CRA and the GSEs by citing the hard data but I don’t any longer because it’s a huge waste of my precious time. The CRA and the GSEs meme is a gigantic smelly red herring.

    All I really want to say is carefully research the issues for yourself and you’ll see that they are both abject hacks who must be extremely well paid by other interests. (Trust your instincts.)

    P.S. I’m not even going to waste my time defending this statement, so take it as you will.

  52. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    6. January 2010 at 15:26

    ‘You are essentially repeating the arguments in the Liebowitz paper, which Simon K and Thruth have addressed better than I can.’

    Actually, they didn’t. Especially since Simon K obviously hasn’t read the paper. He only skimmed a few of its graphs and made some entirely irrelevant commentary about them, without recognizing that those graphs apply to only one part of the paper (a part I haven’t gotten around to commenting on yet).

    The reason I presented parts of Liebowitz’s argument to you was because you had claimed: ‘I have seen little evidence of a “concerted assault”, implying some sort of leftist conspiracy.’

    But, you have exposed yourself as someone who indeed has seen such evidence; IN LIEBOWITZ’s PAPER. And, there’s a lot more I could add, from there as from elsewhere. I haven’t talked about the Comptroller of the Currency, Cuomo’s Fed pressuring Fannie and Freddie to buy the relaxed underwriting loans, nor, that when in 1999 during the argument over the legislation allowing banks to become involved in securities trading, as Tom Sowell put it in his book:

    ————–quote————-
    …”that banks given unsatisfactory ratings under the 1977 Community Reinvestment Act be prohibited from enjoying the new diversification privileges” of this legislation.

    Accordingly, when Congress passed legislation removing existing prohibitions against banks affiliating with securities or insurance firms, this new scope of banking operations was in fact reserved for those banks with a “rating of ‘satisfactory record of meeting community credit needs,’ or better, at the most recent examination of each such institution” “” that is, banks that met government-imposed quotas.
    ————-endquote———–

    What a pity you’ve suddenly lost interest in the topic. As for your new comment:

    ‘Also, you now appear to be explicitly arguing that the problem was loans to minorities (and not a general weakening of lending standards overall). Yet the data shows minimal linkage (if any). Where is your data? Even Liebowitz, after spending half the paper complaining about minorities, then goes on to blame the crisis on something else.’

    That is evidence of either very poor reading skills, or…something even less admirable. You again–even after I’ve pointed out to you that we’re complaining about politicians who use ‘minorities’ as a means to their own selfish ends–try to slander both me and Stan Liebowitz as, ‘complaining about minorities’, i.e. we’re racists. I find that to be way below the standards of the commenters here at The Money Illusion.

    Then you complain:

    ‘Nor does your narrative explain why the credit agencies gave these MBS traunches AAA ratings…’

    Well, I haven’t gotten to that part yet, but since you ask, if the ‘concerted assault’ on underwriting standards had either failed, or, better still, had never occurred there wouldn’t have been any such ‘MBS traunches’ to rate, would there? Which is what I’ve been arguing all along.

    But, since they did give them AAA ratings, the answer is the same ‘concerted assault’ I’ve been detailing; political pressure on the ratings agencies. They are, after all, in a privileged position, protected from competition by acts of congress. If you were in such a position would YOU antagonize your benefactors by nixing their pet cause?

    ‘…or why so many middle/upper class white people in exclusive neighborhoods were impacted…’

    Which doesn’t appear to be the case, if you look at the data. But, to the extent it happened, it was, as I’ve already explained, the house flippers.

    ‘…or why stockholders of banks who were buying all these minority loans didn’t short sell the banks much earlier, and many many many other dynamics that appear more important.’

    They might well have shorted bank stocks, but in that game timing is everything. As Stan Liebowitz has written about with some wry amusement in his book, ‘Re-Thinking the Network Economy’ where he relates how he lost substantial amounts of his daughter’s college fund shorting the dot.com boom.

    Ciao.

  53. Gravatar of Simon K Simon K
    6. January 2010 at 15:41

    Mark – I only came across Pinto today and I already think he’s a hack! It really doesn’t take a lot of research – just a vague familiarity with the mortgage market and a sense for the holes in an argument. I’m not sure whose paying him, but since he’s a “mortgage industry consultant” we sure know which side his bread is buttered on. Am I naive in being appalled that the WSJ prints this stuff?

    Unfortunately, the whole blogosphere seems to have been taken in by this particular stinker of a non-story, so I’d appeal to you to please continue wasting your time on this. I don’t seem to be able to resist the urge to waste mine. While there are vocal people like our friend Patrick around, who’ll probably continue to cite that Liebowitz paper even though it doesn’t even say anything coherent, we should at least help people like Scott to understand why the story they’re selling just isn’t plausible.

    I’m being more dogmatic now than I was earlier because, like Q above, I looked at FNMA’s 2008 Q3 10Q and couldn’t work out what Pinto was talking about when he claimed it “admitted” they’d been passing off loans that had “some of the characteristics of sub-prime and alt-A” as prime until I found this statement:

    “We have classified mortgage loans as Alt-A if the lender that delivers the mortgage loan to us has classified the loan as Alt-A … We have classified mortgage loans as subprime if the mortgage loan is originated by a lender specializing in subprime business or by subprime divisions of large lenders … we have other loans with some features that are similar to Alt-A and subprime loans that we have not classified as Alt-A or subprime because they do not meet our classification criteria.”

    But this is not a shocking confession at all. Sub-prime, prime and Alt-A are mortgage industry terms for groups of products. They are not descriptions of specific loans. Prime loans are made at high LTV ratios and to borrowers with low FICO scores (although not usually both), and sometimes even with limited documentation because there are compensating factors. Fannie Mae holds such loans and has done at least for a very long time – all the 10Qs I looked at broke out the loans by FICO and LTV. There’s a whole complicated rigamarole of guidance from the GSEs about what is and is not acceptable, what factors compensate for what, when PMI is required, and what the yield needs to be. All of these loans are considered to be prime.

    Wallison, though, confuses the issue by muddling up statistics about specific loans (FICO scores under or over 660) with statistics about classes of loans. That and a careful choice of time period lets him imply (although he never actually says) that the GSEs committed fraud by lying in their earlier 10Qs. His readers, like Scott and others above, will then go on and actually say they committed fraud.

  54. Gravatar of Simon K Simon K
    6. January 2010 at 16:52

    Patrick, believe me I’ve read Liebowitz’s paper more times than I want to. For some reason people keep bringing it up as if it actually proved something. Please try to pay attention to the logical structure of his argument: Liebowitz doesn’t have any evidence that all this stuff you keep parroting about the CRA and lower lending standards and the GSEs actually had any affect on the market, so instead he tries to show that sub-prime wasn’t the problem, presumably leaving his argument as the last man standing. This is why his graphs matter – they’re supposed to show that sub-prime versus prime wasn’t relevant. My “irrelevant commentary” on the graphs shows that this wasn’t the case, if you read the data correctly.

    It seems you really want someone to argue with you about the first half of Liebowitz’s paper. I don’t really want to, because there’s no evidence its an important component of the crisis, so like Statsguy I’m walking away from this particular discussion. Byee.

  55. Gravatar of ssumner ssumner
    6. January 2010 at 17:03

    Mark, The fiscal stimulus was reported as 2.2% of GDP in Australia. But new Keynesian models say the entire stimulus should impact the economy when it is announced, not when it is spent.

    The “dire straights” in the US and UK that you refer to were created by tight money at the Fed.

    I doubt that Fed would have done nothing without fiscal stimulus. Even the hawks at the Fed oppose deflation.

    Statsguy, A lot of conservatives say the F&F contributed to the bubble by buying lots of MBSs. It seems you agree. In your mind it may make a difference whether the MBSs were bought before or after the crisis blew up, but to an anti-government-type like me, it really doesn’t make any difference as long as the private sector villains could rationally anticipate that F&F would ride to the rescue. It’s all just more government moral hazard, regardless of whether they look like bad guys or not.

    thruth, I agree. I read that no other country has that sort of entity. Is that right? If so, why do we need them?

    Statsguy, That information on Texas is quite interesting. If that is true, there should be almost no defaults in Texas, because they never had the housing bubble, hence their prices only fell a little bit. Even an unemployed worker would be better off selling the house trather than defaulting on a debt that is only 80% of its value. Could homebuyers in Texas get around the law by borrowing from out of state banks, or did it apply to any loan on Texas property?

    Texas and Denmark—what an interesting combination.

    Simon K, But F&F were in trouble even before Lehman failed, which means it wasn’t just due to falling NGDP. They must have had a lot of bad debt, otherwise why would the government have had to take them over in the middle of 2008?

    Mark, They may be hacks, but no one has refuted the charge that we are going to have to pay 100s of billions bailing out F&F. I don’t care if they were forced at gunpoint to take bad debt off the banks’ hands. I see them as part of the government, so I view it as government failure at a massive level. It isn’t like FDIC where we are legally obligated to protect depositors. If statsguy is right, we are essentially bailing out bank creditors and shareholders, which even FDIC doesn’t necessarily do. It creates a giant moral hazard problem. I wish I had known about this before I wrote the moral hazard piece that Megan McArdle commented on.

    It’s even worse than the TARP loans, because at least those are being repaid. And if they aren’t, we take it out of the stockholders’ hide. Or did I misinterpret statsguy’s information?

    Everyone, I don’t have strong opinions either way on the ratings agencies. They seem to have been quasi-public agencies, but I really don’t expect much from them. If lots of big banks thought MBSs were great investments, I wouldn’t expect the ratings agencies to have had a different opinion. So I blame neither the government nor the private sector for that failure. After all, I believe in the EMH.

  56. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. January 2010 at 17:18

    Scott,

    I’m not letting this go at all without a fight (how many rounds has it been fans, if any?).

    You wrote:
    “The “dire straights” in the US and UK that you refer to were created by tight money at the Fed.”

    That I think is, and was, my whole point.

    You wrote:
    “I doubt that Fed would have done nothing without fiscal stimulus. Even the hawks at the Fed oppose deflation.”

    Have you personally spent some time with Charles Plosser? I have.

    I think you are amazingly naive for someone who understands monetary economics (as well as I do.)

  57. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. January 2010 at 17:38

    Scott,
    You wrote:
    “They may be hacks, but no one has refuted the charge that we are going to have to pay 100s of billions bailing out F&F. I don’t care if they were forced at gunpoint to take bad debt off the banks’ hands. I see them as part of the government, so I view it as government failure at a massive level.”

    I view it as the government as taking on a debt that was the result of extremely poor government regulation. Anyway you look at it, it was almost certainly poor public policy. We got screwed because we basically screwed ourselves.

    That is, unless you really like self-flagellation. In my opinion it’s almost never a good thing.

  58. Gravatar of Simon K Simon K
    6. January 2010 at 17:43

    Scott – It is true that Fannie and Freddie were in trouble before NGDP started to fall. This does speak to the quality of their loan portfolio – clearly it was more exposed to falling house prices than they believed. However, as others said above, their loan portfolio and the loans they guaranteed were better than some of the other junk that was out there in 2008. The implication is that while they did participate in the boom and consequent bust, they were not particularly a driving force behind it, and they did not actually deceive their investors about what the were doing.

    Having said that, I fully agree with you that they’re introducing moral hazard into the system. But I think they always did so – at the very least they make mortgages look like better investments than they really were for a long time by absorbing much of the risk themselves.

  59. Gravatar of StatsGuy StatsGuy
    6. January 2010 at 18:59

    Scott:

    “…but to an anti-government-type like me, it really doesn’t make any difference as long as the private sector villains could rationally anticipate that F&F would ride to the rescue.”

    I think you’ve rediscovered your anti-government roots because you’re at a conference with your buddies.

    Anyway, it makes a huge difference. Above you state the reason that F&F needed more money may have been fraud (rather than TBTF, more generally). You cite as partial evidence the increase in govt commitments, but then you discount the evidence that F&F obligations increased AFTER their failure (because it was easier to feed money through F&F to other institutions and blame F&F, than to give money directly to those other TBTF institutions).

    Arguing the primary problem was F&F implies that we don’t need to fix all the other problems – just fix F&F. That is the current conservative mantra, which culminates in the argument “we need even MORE deregulation!” The assignment of blame directly implies a future course of action.

    But fixing F&F does NOT fix the TBTF problem – Simon Johnson (the TBTF champion sin qua non) cites at least 6 major TBTF institutions. Thus, the implication of timing is critical – had F&F not been the vehicle of rescue for these TBTF politically powerful institutions, it would have been another vehicle. Consider… AIG was not government owned, until after the fact, and it’s a complete certainty that dozens of banks would have gone under without the govt making AIG the vehicle for rescue.

    F&F was just one piece of the problem – more a symptom than a root cause – but you are specifically endorsing a conspiracy theory to move F&F (and fraud therein) to a central role. Since I know you are not a fan of conspiracy theories, I would urge you to thoughtfully consider how much weight you want to give to the F&F fraud hypothesis.

    Regarding Texas:

    Texas had very low default rates until fairly late in the recession, and likewise lower unemployment as well. But when October 2008 hit, it tanked like everyone else. It’s somewhat ironic that Texas, of all places, was the state where regulation saved the day.

    The 80% rule was part of a comprehensive battery of consumer protection rules passed in 1998 (by a democratic state legislature and a certain republican governor named George Bush)

    Oh, the irony.

    http://www.consumersunion.org/finance/policy-rpt1002.htm

  60. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    6. January 2010 at 19:17

    ‘Patrick, believe me I’ve read Liebowitz’s paper more times than I want to.’

    Frankly, I don’t believe you, as you still don’t understand what the graphs you’re referring to were designed to illustrate.

    Quick, without looking, tell me what section of his paper they were in, and what theory were they testing.

  61. Gravatar of ssumner ssumner
    7. January 2010 at 19:46

    Mark, you said;

    “Have you personally spent some time with Charles Plosser? I have.

    I think you are amazingly naive for someone who understands monetary economics (as well as I do.)”

    It’s funny, I was just thinking about Plosser and the other hawks. How many FOMC memebers actually like things the way they are? How many think it would be bad if NGDP grew faster than the Fed now expects it to grow? Seriously, I want names. I’d like a list of the economists who caused the Great Recession. And faces. And I’d like to know how many of them went to the University of Chicago or similar schools. I have an uneasy feeling that my alma mater might have caused this disaster.

    And yes, I am incredibly naive. But I don’t think even Plosser favors a Depression. And if he does, I don’t think Bernanke does.

    Simon K, We had this debate all year in other threads. And I’ve never accepted the argument you are making. During the 2006 boom I don’t recall meeting a single person who didn’t know what was going on. Every social event people talked about how amazing it was that banks were shoveling money to anyone who could fog a mirror. This was common knowledge among workmen who never went to college. I have zero sympathy for the poor investors who were fooled by the banks. And of course the banks also lost hundreds of billions, so they mostly fooled themselves. (Of course when I say they knew, I mean the low quality loans, not the fact that housing prices would tank.)

    Statsguy, I am not convinced by your argument on several levels:

    1. If we abolished F&F and FDIC, it would send a signal that we planned to go back to the 1920s, so I don’t think you can simply say “someone else would have bailed them out.” I am talking about long run policy issues here.

    2. You haven’t yet convinced me that F&F are subsidizing the commercial banks. I need data. What prices are they paying for these MBSs? The subsidy would be the gap between the price F&F pay, and the equilibrium market price. Do you have any data on that, or are you just guessing?

    3. Many of the commercial banks are doing OK. You claim that the F&F purchases are just replacing some other subsidy like TARP loans. But there is a huge difference. The TARP loans are being repaid. Even assuming you are right, the F&F implicit subsidy will never be repaid. So I’m still not on board.

    You defense of government might have made sense when an (allegedly) anti-government Bush was in office, but Obama is doing the same stuff as Bush did. Is Obama part of a conspiracy to make the government look bad and the private sector look good?

    I am not saying that in the end you are wrong. You might have an argument. I am just saying it isn’t nearly as clearcut as a year ago, when it looked obvious that the subprime fiasco was mostly a private sector screwup. Now that is a hypothesis that is yet to be established

  62. Gravatar of thruth thruth
    7. January 2010 at 21:09

    Scott Sumner said “1. If we abolished F&F and FDIC, …”

    Half baked thought experiment: If you did this and simultaneously switch to an NGDP targeting regime wouldn’t this amount to the equivalent of a comprehensive FDIC? You would avoid large scale bank runs by printing money to ensure the banks can meet whatever the demand for funds would be. To do otherwise would result in a fall in NGDP. Would we see isolated bank runs a little more frequently than we do now?

    “2. You haven’t yet convinced me that F&F are subsidizing the commercial banks. I need data. What prices are they paying for these MBSs? The subsidy would be the gap between the price F&F pay, and the equilibrium market price. Do you have any data on that, or are you just guessing?”

    If they are, it’s through refis of troubled mortgages and allowing banks to keep originating rather than MBS purchases. (I don’t think they are buying much, if any, non-conforming MBS at all now). I don’t think this would be in quite the same ballpark as TARP for propping up the banks but it isn’t insignificant.

    “3. Many of the commercial banks are doing OK. You claim that the F&F purchases are just replacing some other subsidy like TARP loans. But there is a huge difference. The TARP loans are being repaid. Even assuming you are right, the F&F implicit subsidy will never be repaid. So I’m still not on board.”

    Even though it’s misleading to evaluate subsidies ex post (at the time the loans were very generous and no doubt saved many from bankruptcy, albeit due to Fed inaction) I think you are basically right. The banks started with more capital, blew through, raised even more and blew through it again before finally succumbing. The GSEs had very little capital, blew through and then the market decided it was time for that implicit backing to become explicit. Nature of the beast. All those years coasting with zero budgetary impact comes home to roost.

  63. Gravatar of StatsGuy StatsGuy
    8. January 2010 at 06:48

    ssumner:

    “You defense of government might have made sense when an (allegedly) anti-government Bush was in office, but Obama is doing the same stuff as Bush did.”

    In the financial realm, he sure is.

    It was NOT my primary intent to defend government broadly here, nor even to comment on whether F&F are good or bad overall, but rather to challenge the argument that the reason F&F needed >400 billion in extra funds was because of fraudulent statements about mortgage contracts or because the F&F situation was much worse in Jan 09 than anyone knew. There are two lines of rebuttal

    – the mortgages weren’t that bad compared to prior statements/other banks
    – and the real reason for >400 billion was because of changes in the political use of F&F over the last year to support the banking system. (This latter line of argument is certainly NOT a defense of government; it’s an attack against govt. capture by banks.)

    I don’t even challenge that F&F had a role in the crisis when comments raised the argument that anti-redlining policies to reduce mortgage underwriting standards for minorities caused the crisis – I disagreed that it had THE central role in the crisis.

    Your general response was “it really doesn’t make any difference as long as the private sector villains could rationally anticipate that F&F would ride to the rescue.”

    Yes it does. The narrow argument is F&F was vastly worse than we thought, the wider argument is TBTF (including politically powerful banks) is worse than we thought. One explanation implies we should scrap F&F. The other implies we need to fix the banking system.

    “What prices are they paying for these MBSs? The subsidy would be the gap between the price F&F pay, and the equilibrium market price.”

    As you well know, equillibrium price is strongly affected by F&F demand because they are half the market, which is the entire point. The subsidy exists in the fact that F&F would be able to (and indeed, _compelled_ to) continue operations through subsidized access to capital when they were essentially insolvent (far below the rates of what the private sector would allow). Without increasing govt subsidies, F&F demand would have fallen through the floor, and with it asset prices (meaning MBS rates rise dramatically). In so far as this shifts the equillibrium price for assets up (which is _exactly_ the point), it’s a subsidy, and the scale of that subsidy was substantially increased over this past year.

    To measure this subsidy, we would need to estimate the counterfactual – “What would prices have been without increased F&F activity which was subsidized by govt.?”

    I will provide data on F&F mortgage mods and the relative size of F&F activity in the mortgage market later today when I have more time… I know you are busy and going through arguments quickly; hopefully I faithfully summarized the relevant parts of this contorted thread.

  64. Gravatar of Simon K Simon K
    8. January 2010 at 10:32

    Scott – I’m not sure what argument I’m making that you don’t accept. All I’ve really said is that there’s no empirical evidence government pressure for lower lending standards was a key driver of the boom, and that Fannie and Freddie didn’t lead the way in making or buying sub-prime or Alt-A loans. I’m sure the quality of F&F’s prime, conforming loans did deteriorate during the boom – it was essentially impossible to buy a house in the bubble areas with a conforming loan, and buyers and brokers “innovated” a great deal to work around that, in ways that undeniably undermined the loan quality.

    As to whether they knew the loans they were guarnateeing were riskier than they looked, which is essentially what Pinto is complaining about when you strip away the bullsh*t, they probably did, but they probably didn’t care. In this they were in the same boat as the private label mortgage lenders – who cared whether the buyer could repay the loan when the house would be worth 120% of the loan amount next year?

    Its interesting that you say in this thread that “everyone knew” lending practices were not sustainable, but in the bubble thread that no-one knew it was a bubble. Seems like a contradiction – the unsustainable lending practices looked just fine precisely because everyone thought house prices would keep going up.

  65. Gravatar of scott sumner scott sumner
    9. January 2010 at 10:21

    thruth, I agree that NGDP targeting is the key. If we had had NGDP targeting in the early 1930s, the banks runs never would have happened, even without FDIC.

    You said;

    “If they are, it’s through refis of troubled mortgages and allowing banks to keep originating rather than MBS purchases. (I don’t think they are buying much, if any, non-conforming MBS at all now). I don’t think this would be in quite the same ballpark as TARP for propping up the banks but it isn’t insignificant.”

    Why would we want to do this? Wouldn’t it just be repeating the same mistakes?

    I agree with your point three.

    statsguy, I don’t object to what you say, but I have two reactions:

    1. It makes me want to abolish F&F even more. F&F is a convenient tool of corporatism.

    2. This whole “endgame” your describe makes me even more convinced moral hazard is a huge problem. We are not just bailing out TBTF banks. If you are right we are also boosting profits of banks that took smaller risks, were not about to fail, but can sell junk to F&F at inflated prices (Goldman Sachs?) Or am I still misunderstanding your argument? If you are right that they are propping up the entire baking system, I don’t see how that doesn’t help all banks, even the non-TBTFs, or the smart big banks like GS.

    Simon K, On your last point there is no contradiction. I have always said that everyone knew risky loans were being made, I have always been skeptical of the view that everyone knew housing prices would crash.

    On the F&F issue, I never raised the political pressures issue, it was Patrick that is the expert there. For me the bottom line, and the only issue of importance, is the size of the bailouts. If we have to spend more money bailing out F&F and FHA, etc, than the commercial banks, that casts the scandal in a whole new light. It wasn’t a failure of capitalism (as initially believed), it was a failure of corporatism. That is my point.

    I have no view on the fraud issue, as I don’t know enough to comment on the WSJ articles. The criticism from you commenters was very valuable there, as it made me less willing to accept his fraud claims at face value.

  66. Gravatar of thruth thruth
    9. January 2010 at 11:57

    Scott Sumner said “thruth, I agree that NGDP targeting is the key. If we had had NGDP targeting in the early 1930s, the banks runs never would have happened, even without FDIC.”

    Still seems like you could get isolated runs concentrated in a few banks even in an NGDP targeting regime. Given political concerns about fairness, I think we’d still see the govt occasionally intervening to provide blanket guarantees and/or prop up individual banks to protect depositors. Private deposit insurance hasn’t really sprung up to fill the void in other countries, which seem to rely on an implicit backing (or in niche non-FDIC covered segments in the US). In any event, a private insurer would probably devolve into an FDIC like entity with implicit or explicit backing, because only the govt can credibly commit to backing the entire system.

    I said “If they are, it’s through refis of troubled mortgages and allowing banks to keep originating…”

    You replied “Why would we want to do this? Wouldn’t it just be repeating the same mistakes?”

    Well yes and no. You have made the argument that housing and mortgage markets have collapsed more than necessary. This mightn’t be the most efficient way of propping up NGDP, but surely it has some effect? More importantly, the directed actions of the GSEs certainly helped to reduce the subsidy associated with TARP, it’s just a question of magnitude.

  67. Gravatar of ssumner ssumner
    10. January 2010 at 19:29

    thruth, I just don’t see the need for FDIC with NGDP targeting. I think the market would do fine without it. Canada didn’t have deposit insurance until 1967, and never seemed to have the sort of problems we do.
    US banks were much more conservatively managed before FDIC. That’s what we want, isn’t it?

    I don’t agree that bailing out housing helps the economy, in my view is simply shifts demand from other sectors and creates additional inefficiences. Remember that every dollar the federal government spends must be raised with taxes that, at the margin, involve highly distortionary taxation. (Unless you think we are about to adopt a VAT.)

    You said;

    “More importantly, the directed actions of the GSEs certainly helped to reduce the subsidy associated with TARP, it’s just a question of magnitude.”

    Obviously that could well be true, but I haven’t seen any evidence to convince me that the savings are more than 10 or 20 cents on the dollar.

  68. Gravatar of thruth thruth
    12. January 2010 at 09:48

    At the risk that you won’t see this, I thought I may as well respond to these:

    ssumner said “I just don’t see the need for FDIC with NGDP targeting. Canada didn’t have deposit insurance until 1967, and never seemed to have the sort of problems we do.”

    I agree that we don’t need anything as comprehensive as FDIC. But I don’t think you can rule out the possiblity of “operational risks” associated with any targeting regime, and that may require additional interventions. The question is whether you want to have institutions standing ready to fight the fires or just rely on ad hoc solutions. I don’t know about Canada, but other nations don’t have deposit insurance but do rely on ad hoc guarantees and bailouts in crises. Perhaps “ad hoc” reduces moral hazard?

    “US banks were much more conservatively managed before FDIC. That’s what we want, isn’t it?”

    Agree. As a foreigner who grew up in a country (Australia) without deposit insurance, the statement “Your account is covered by FDIC insurance up to the maximum allowed by law” footnoted in most bank account brochures has often struck me as an implicit reminder of the untrustworthy nature of the institutions…

    “I don’t agree that bailing out housing helps the economy, in my view is simply shifts demand from other sectors and creates additional inefficiences. Remember that every dollar the federal government spends must be raised with taxes that, at the margin, involve highly distortionary taxation.”

    I was thinking in terms of a Krugmanesque new Keynesian model, in which fiscal policy becomes effective at the lower bound (presuming a Fed that refuses to engage in QE etc). I’m not sure I believe his multiplier estimates, but I doubt they are zero/negative. (I think there’s a recent working paper by Christiano et al in support of this)

  69. Gravatar of scott sumner scott sumner
    12. January 2010 at 14:02

    thruth, I may do a post on a new study showing no effect from transportation project stimulus.

    I can’t add much on deposit insurance. Small countries that provide it are just providing a wasteful subsidy to banks, as without it there would be plenty of insurance protected foreign banks subsidized by those foreign governments.

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