October 23, 2008
POLITICS/BUSINESS: Opening Your Mouth And Removing All Doubt
Megan McArdle advises Matt Taibbi to stop. And has some good advice for people who only tuned in to the financial world during the credit crisis:
No one who did not know what a CDO was before the crisis should be opining as to the causes or the possible solutions. And anyone who tells you that they understand exactly why this happened, why we got this crisis instead of the dollar crisis we were expecting, and what kind of regulations will unquestionably fix it, is definitionally too ignorant to be opening their mouth.
The funny thing is Taibbi ranting about the institutional market for securities backed by bad loans...while at the same time refusing to address the bad loans themselves except to deny they had any role. That failure of basic logic alone is hilarious.
The overextension of housing credit, which formed the collateral for the various instruments whose loss of value set off so many other dominos falling, was, by definition, at the root of the crisis. Now, was the root of the crisis the only cause, or the only thing we ought to avoid repeating? Are there other, second-order aspects of the system that made it more vulnerable to the contagion from loans to un-credit-worthy borrowers based on overvalued real estate? Of course not, and as McArdle says, the fact that we can piece together some significant contributors to the crisis does not equate to understanding fully why it happened.
Then again, while I understand McArdle's call for a cool, academic assessment of the multiple factors involved after we get more data, that approach is entirely impractical in the middle of a contested election, in which both sides are naturally going to have to answer voter questions about what happened and why. It would be political malpractice for Republicans not to make the (accurate) point that the roots in the lending/housing market are the part of all this in which bad public policy played the most direct role in distorting the market away from its natural equilibrium. And it's likewise a slam dunk to point out that had Republican-led legislative efforts to rein in the GSEs not been stymied in the 2001-2005 period, the situation would have been, at a minimum, much more tractable to deal with, and that Democratic opponents of such efforts had longstanding financial and ideological reasons to oppose them.
I kept meaning to do a longer post on the inevitable (even if McCain wins) mania for more regulation, although I could just as easily refer you to McArdle's entire blog for that. Here, for example, she points out the obvious fact that regulators are human and not generally wiser than the businesses they regulate:
Nor is there any particular proposal for preventing that institution from falling prey to the same forces that grip the regulated industry. I have said it before, but it is worth repeating: the regulators became overconfident in the same way, and for the same reasons, that the bankers became overconfident. Just as a long and unusually rosy period in the housing market convinced the bankers that they had gotten better at pricing credit risk, a long period without a large bank failure persuaded the regulators that they had gotten better at regulation. They believed that their computer models, and an improved understanding of how markets and the economy worked, would allow them to see problems in time and halt them. Obviously, they were wrong.
Regulators, no matter how diligent or well-staffed or well-funded, never have
(1) The same degree and timeliness of access to information about a business and its daily operations as the people who run it and interact continuously with its employees; or
(2) The same incentive to ensure the continuing profitability of the business as the people who draw their income from it.
Also, while you do get good people who go into government for all sorts of reasons, people who have the specific skill set of being really shrewd observers of financial markets are probably the people least inclined to take far lower-paying jobs regulating those markets than making money in them; draw what conclusions you will about the ability of the regulatory agencies to be all-wise and all-seeing under the best of circumstances.
Now, if you are talking about regulating an industry to keep it from unscrupulously ripping off other people outside their businesses, at least you have an argument about whether people with less competence and less information are nonetheless properly charged with restricting the business' operations. But the crucial issue in debating the second-order aspects of the credit crisis (i.e., why institutions let themselves get overexposed to risks derived from bad loans), at the end of the day, is whether regulators were better situated to protect the interests of the financial industry itself than the people who worked in it. You should expect some skepticism about that kind of argument.
Effective and rational regulation is not the goal. Democrats want to pass a law (any law), declare victory, pat themselves on the back and feel good about themselves.
Reasons the Federal Government Should Regulate Financial Institutions:
1)Protect consumers/investors, i.e. the little guy, from getting ripped off. Examples: the Truth in Lending Act; the Real Estate Settlement Procedures Act, both of which apply to lending institutions. Also the Securities Acts of 1933, 1934 and 1940 - all of which regulate the sale of investments. Interestingly, investors of certain income and wealth are not protected by some of the investment regulations (they’re not little enough).
2)Protect the Government’s Investment – FDIC is the most notable example; it monitors the safety and soundness of commercial banks because if the bank fails the government is on the hook for the deposits. The FHA also limits certain types of mortgages because otherwise they will not be insurable through federal programs.
3)Implement Public Policy – The Community Redevelopment Authority (CRA), Fannie Mae and Freddie Mac, Equal Credit Opportunity Act (though this last one could also fall in with the first category).
4)Protect the Economy at large – The FDIC is probably also the best example of this last category too. The government guarantees the deposits in all banks so that people trust banks, thereby encouraging savings and avoiding bank runs. The examples mentioned in #1 could also arguably fall under this category too, because a general sense of trust is usually good for the economy.
Crank correctly notes that the first reason (protecting the little guy) has no bearing on any potential regulations of Investment Banks.
And we should be very leary of any regulations to Implement Public Policy (see Disaster, Fan & Fred Mae).
So that leaves #2 -- which really only became relevant with the latest bailout and #4: Protecting the Economy at Large.
Speaking of rationalizations and McArdle -- did you know that she is backing Barack Obama?
I find that baffling, especially since she won't explain some of her thinking. For instance, in one post she claimed that Obama is "well-informed". In the comments, several people, including myself, asked her for evidence for that proposition. She didn't reply. So, I followed up with a couple of emails. She still hasn't replied and it has been many days.
She may -- like some other Obama supporters -- think that Obama is lying to us, and would be more libertarian than his words suggest. But to believe that, you have to ignore his record and some of his nastier associations.
Just so, to the post and the comments above.
If the underlying collateral didn't turn out to be junk, we're not in this pickle. I don't care how you slice and dice the income stream, if it's reliable--creditworthy--this never happens.
If you want to regulate anything, regulate mortgage brokers and the ratings agencies. I wouldn't recommend that, but that's where the system broke down.
Sponge, the collateral was junk, and always was. When you think about it, any money or credit system is junk if you think it is, whether it's based on gold, silver, dollars, houses or tulips.
Here is how it started: the Phoenicians learned how to assay gold with a touchstone (gold leaves one mark on it, iron pyrite another), so they could actually begin international sea based trade based on a common currency, which everyone had faith in: once faith is lost, the currency, NO MATTER WHAT, has no value.
So Holland lost faith in tulips, we lost faith in stocks (in 1929), and now we finally realized that a house is a home. A people that has any form of currency needs to know that whatever it's form, nuggets, paper, electronic credits, quatlous, doesn't matter, has to have an equivalent across the board. So banks have to be regulated, as do the businesses that help create this income. The trick is knowing when to hold off, and also, what you do have to regulate. Sarbox is an attempt, and not a great one, that we have to trust our external audits. And so forth. We will always trust (well I think we will) a large down payment based on collateral, which was a gimme after the Great Depression; now it's a gimme again. No more borrowing on trust alone for a few generations until the next group forgets and becomes stupid. So Sponge, I would regulate what percentage of anything on a real estate or publicly traded market can be loaned. Back to the 20% down payment, and we would have had no issues.
Carlo Ponzi (yes there was one) must be laughing in his grave.
I would lean toward Sponge's solution. The brokers were running boiler room operations, and unlike stock scammers no licenses or regulatory oversight. The rating agency leaders must get perp walked asap. Anyone following the emails disclosed last week? Then knew exactly what they were doing. As for the PM buyers of this trash paper they did not do due diligence, shirking their fiduciary responsibilities. Instead of examining the underlying they accepted the rating at face value. they should be fired, shamed, and sued.
The oil tumble continues, slapping russia, hugo, and iran nicely. Funny how bubbles pop, no?
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