- 1) Community Redevelopment Act[CRA] as originally written had nothing to do with the bubble but was a factor in Credit Default Swaps [CDS] as a hedge against loss. Banks were judged on their CRA rating and that 'forced' them to make loans in areas where a trend was showing crime, vacancies and business pulling out made them a bad risk. The buyer wasn't a risk, the house was well constructed, but if the homeowner were injured or lost their job, the home might be worthless on the market. Banks don't print money (Fed reserve aside,) so they cannot make loans of their depositors money except on sound risk.
- 2) After CDS became the norm and pushed off from the mother ship (the banks,) loans became a commodity. If a broker sold a house and wrote the loan for maximum amount, their % of commission was higher and they could actually 'sell' the loan to a CDS broker. This caused brokers to run around making second mortgages in the 10's of thousands on kitchen remodels with no concern that the loans exceeded the value of the home. Again they sold them for % profit.
- 3) On C-SPAN I have had very informed sources answer this question: If Americans were negative savers (because both Greenspan and Bernanke kept interest at 1% which discouraged savings and encouraged spending,) where did the US$s that financed all these risky home loans come from? The normal process is a saver puts money in bank at a certain interest rate and the bank loans that money at a higher interest rate on good solid 'risks' to make bucks.. But, we had no savings. The answer was the federal reserve created the money used to fuel the bubble. Its like a forest fire with lots of downed trees, branches and brush.. it burns very hot and destroys the trees.
- 4) So the circle was complete; the bubble grew. Greenspan or Bernanke could have (should have) raised interest rates like Volcher did to let the bubble deflate and give us several good years of growth again. The only way to deflate a bubble is to deflate it--in our case by not printing so much money and raising interest rates. The pain is hard, but its over fast. No Politician wants that. The federal reserve is very much in tune with politics and the administration in power.
- 5) Yes there was greed with flipping homes and some got caught with the hot potato when the bubble burst. There was greed in Goldman and other banks selling a faulty investment. There was greed in the loan makers who would shop the neighborhood to find a home that sold for a huge amount so they could make the loan (and their commission) higher.
Sunday, November 21, 2010
What causes bubbles?
Matt Taibbi, an author I do admire, has read Cato's take on the housing bubble and written about it here in Rolling Stone. Now I doubt Rolling Stone will pick up on my humble response, but I do have a point or two to make.
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On CNN I just heard the statement: no connection between lender and borrower. Exactly what I said above.
ReplyDeleteOK, thanks for posting this. Taking your points one at a time:
ReplyDelete1) CRA loans were a small % of subprime loans, and they defaulted at a lower rate compared with other subprime loans. I know of no relationship between the CRA and CDO derivatives. Banks weren't "forced" to make bad loans. CRA prevented redlining (rejecting loans solely based on location), and those loans were largely successful.
2) I pretty much agree, although I think the selling off of loans was a common practice prior to the subprime bubble. However, the derivatives definitely accelerated the bad practices you outline.
3) Dunno about this. What evidence do you have the Fed was increasing money supply in this period? As far as I know, the low-interest rate environment (which you correctly put at the feet of "The Maestro" -- Greenspan) was a chief driver of accelerating prices, and created worldwide inflows to the US capital markets, much of which cash came from outside the USA. Plus, fund managers in the USA bought a lot of what Goldman was selling. I think you're trying to create a connection to the "worthless fiat money" meme here, but you have to remember that inflation was very very LOW throughout this period.
4) Yes to the first part. They kept rates too low for too long. Yes, the politicians in power encouraged this. Until the bubble bursts everything just great to them. But when you say "the federal reserve is very much in tune with politics and the administration in power" I think that elides over something else that was very important, which is that Greenspan was an Ayn Rand acolyte (part of her NYC circle), and was very much a free market fundamentalist. As he famously testified, he made "a mistake." That mistake was thinking that all the actors on Wall St were acting in the long-term interest of their institutions. In other words, he completely discounted Wall St GREED as a motivating factor in things like the Ratings agencies, and in the investment banks whose LTV ratios went through the roof.
5) Yep.
Bottom line (and I'm sure you'll disagree): the market needed MORE regulation, not less. It would be nice to think that all of these entities would simply regulate themselves, but it didn't work that way, and it wasn't because of the government. Now thanks to all the cross-pollination (I'm putting it nicely) between gov't and Wall St, we're all going to have to pay for their lying and greed. Oh well?
Thanks for your thoughtful post!
-RockDots
One more thing: I would be remiss if I didn't acknowledge that the thing that makes us Liberals crazy about the CRA argument is that it seems like an effort to divert blame for the whole mortgage crisis from the greedy and powerful banksters, to the vulnerable and relatively powerless poor and esp. minorities. So there's that!
ReplyDelete1) I never said that the CRA caused all the problems. What I said was that when they could only consider the buyer and not trends in locations, some started to create new divisions for SOME loans they were uncomfortable with. That started the sell off, and http://tinyurl.com/b96b6h <--Recipe for Disaster: The Formula That Killed Wall Street, was a factor. This article does give David X. Li's Gaussian copula function blame for judging CDS as AAA rating. And the bond market of retirement funds which I don't understand. One smart guy's formula hurts us all.
ReplyDelete3) From 1970 when a nice family home could be purchased for under 20,000, we paid 24,000 for an all brick, 2 bath that year, the sweep of rising home values moved across the nation. The rule was 10% down and home value no more than twice annual salary.
I know Greenspan was a Rand follower but he tossed all that aside when he took over the fed. He knew all about the horrors of fiat currency but he desperately wanted to please. And I honestly began to believe in himself as a Maestro. In that effort, if you don't think housing prices exploded under his reign while he kept interest rates too low to encourage savings, I don't know what more I can say.
A bubble means too much money has been 'mal-invested' and a lot of investors will be hurt, but its like a band-aide. Do it fast. Get it over with. I am very concerned its coming again and this time the currency may not survive it.
As far as market regulation.. why wasn't Madoff prosecuted. A reporter gave the SEC all the proof and they still sat and looked at porn. Most regulators become too friendly with their industry and end up helping keep out competition, not ending schemes.
Contracts need to be enforced by courts. Laws need to apply to all. And no big corporations should ever be able to use the arm of government, laws, to keep out competition. Today our system is corporatism.... all designed to write regulations that are skewed to help some industry big shots or protect them.