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The Loan-Filled Lending Crisis
In the Wall Street Journal, Cato's Alan Reynolds makes the oft-neglected point that, until the last week or so, the presumed national "credit crunch" over the past year has yet to actually reduce the amount of credit:
Bank loans to commercial and industrial business, real estate and consumers continued to expand nearly every month. Commercial and industrial loans exceeded $1.5 trillion this August, up from less than $1.2 trillion a year earlier. Real-estate loans exceeded $3.6 trillion, up from less than $3.4 trillion a year ago. Consumer loans were $845 billion, up from $737 billion. Credit standards are tougher, which is surely a good thing, but interest rates for creditworthy borrowers remain low.
Reynolds also makes a point for those who are suddenly pining for the re-imposition of the Glass-Steagall Act, specifically its ban on commercial banks owning investment banks.
that would mean J.P. Morgan could not have bought Bear Stearns, Bank of America could not have bought Merrill Lynch, Barclays could not buy most of Lehman, and Goldman Sachs and Morgan Stanley could not become bank holding companies. It is hard to imagine how things would have worked out in that situation, but it surely would not have been an improvement.
Whole thing here. Then, to be transported to a faraway time and place, go read Reynolds' June 1995 reason piece arguing against a federal balanced budget amendment!
|9.23.08 @ 1:24PM|#
that would mean J.P. Morgan could not have bought Bear
Stearns, Bank of America could not have bought Merrill Lynch,
Barclays could not buy most of Lehman, and Goldman Sachs and Morgan
Stanley could not become bank holding companies. It is hard to
imagine how things would have worked out in that situation, but it
surely would not have been an improvement.
Well, JP Morgan and Barclay's would exist in their current forms if
you reenacted Glass-Steagal. JP Morgan-Chase would be JP Morgan and
Chase (as two companies). JP Morgan would be allowed to buy Bear.
Barclays would have to have an i-bank portion and a commercial bank
portion. When you consider the fact that Barclay's bought Leahman
for its i-bank portion, the new company would probably do the
same.
As for Goldman and Morgan Stanley converting themselves to bank
holding companies, it's a net negative. They did it so they
wouldn't have to mark to market, instead they can identify assets
as held for investment. This is essentially accounting fiction and
could (and should*) have been done away with by Cox. In exchange,
they have to hold higher reserves (a good thing) and they are under
significantly greater banking regulations. To use the
Goldman/Morgan Stanley conversion as a point for Glass-Steagel is
pretty dumb.
* Ending/suspending mark to market is a possible way to not need
the bailout.
|9.23.08 @ 1:29PM|#
that would mean J.P. Morgan could not have bought Bear
Stearns, Bank of America could not have bought Merrill Lynch,
Barclays could not buy most of Lehman, and Goldman Sachs and Morgan
Stanley could not become bank holding companies. It is hard to
imagine how things would have worked out in that situation, but it
surely would not have been an improvement.
And if we hadn't invaded Iraq, we wouldn't have been able to fight
al Qaeda in Iraq.
See the problem here?
|9.23.08 @ 1:29PM|#
"To use the Goldman/Morgan Stanley conversion as a point for
Glass-Steagel is pretty dumb."
How is it dumb when it is factually correct?
|9.23.08 @ 1:35PM|#
How is it dumb when it is factually correct?
Because the same outcome could have been reached merely by ending
the mark-to-market rule. That's the only functional difference
between Goldman and Morgan today and the same two banks a week
ago*. Unless they've started opening bank branches and people have
rushed to deposit money in them (which hasn't happened). All the
conversion has demonstrated is that the banks are financially
stable (they can pay their liabilities), but they're screwed
because of accounting rules. So instead of doing the rational thing
and ending mark-to-market, we're going to buy the shitty
assets.
* Another big difference is they have higher deposit limits and are
exposed to more government regulations. However, that won't kick in
yet.
|9.23.08 @ 1:38PM|#
Joe, the repeal of Glass-Steagall didn't cause this problem, so
your point doesn't apply in this case.
You can make a good case for more regulation, or that deregulation
is bad, but in this case blaming GLB for this banking crisis is not
correct.
|9.23.08 @ 1:48PM|#
DDP,
I think it would be better to say that Glass-Steagel repeal was
only a part of what brought this about, and not the most important
part, but that it played a role.
It had the effect of increasing the number of mortgages made by
non-banks (institutions that weren't federally insured and didn't
have to abide by such regulations as capitalization standards), and
of increasing the amount of those mortgages that got converted into
mortgage-backed derivatives that were over-rated.
Not a dominant role, but some.
Mad Max|9.23.08 @ 1:53PM|#
From the balanced-budget article:
"It is unfashionable to say so, but it makes sense for governments
to finance capital investments with debt, because infrastructure
yields benefits over decades. It also makes sense to borrow during
recessions . . ."
Fair enough - so why not require a supermajority of voters to
approve any additional federal indebtedness? Require the support of
a majority of those voting, plus approval in a number of states
containing a majority of the population and electoral votes.
Experience taught the states to let the voters rule up or down on
the wisdom of most kinds of new indebtedness. At best it would make
the voters themselves accountable, not blaming "those SOBs in
Congress."
Gilbert Martin|9.23.08 @ 1:54PM|#
The number one underlying cause of the financial mess was the
federal reserve creating a real estate asset bubble by pumping up
the money supply, driving down interest rates and devaluing the
dollar.
Other culprits include Fannie Mae and Freddie Mac and the
"Community Reinvestment Act"
And the Sarbanes Oxley "mark to market" rules did indeed greatly
contribute.
|9.23.08 @ 1:55PM|#
joe,
I disagree. If Glass-Steagall's repeal caused this problem we
probably would have seen a joint i-bank/commercial bank fail. In
fact, G-S has made things better because the joint banks are more
stable than a standalone i-bank*. The thing is, those banks have
survived because:
a) They have significant reserve assets to rely on in tough
times
b) They are less leveraged than a standalone i-bank
c) They are more heavily regulated, so are less likely to engage in
as much risky behavior (related to point b)
d) They don't have to mark assets to market price
* This only really applies to the bulge bracket banks. The smaller,
boutique banks have been stale because they avoided hedge fund
activities, prop trading and other risky transactions. They've
pretty much stuck to underwriting and mergers.
Amakudari|9.23.08 @ 2:00PM|#
Barclays would have to have an i-bank portion and a
commercial bank portion.
Barclays is based in the UK and had retail and i-banking before
Gramm-Leach-Bliley passed, so unless my understanding's wrong they
would actually have to split up to acquire Lehman. Granted, I think
the government would have at least allowed JPMorgan-Bear and
BofA-Merrill, especially since they allowed Citi's buying sprees
before GLB.
|9.23.08 @ 2:04PM|#
The number one underlying cause of the financial mess was
the federal reserve creating a real estate asset bubble by pumping
up the money supply, driving down interest rates and devaluing the
dollar.
I hear this argument a lot, but we've seen real estate bubbles pop
before without the losses causing a cascade like this. Absent the
silly games people were playing with other people's debt, a popping
real estate bubble would have been just that, a downturn in a
specific market. Maybe it would have caused a wider recession, but
then again, the "real" economy (manufacturing, exports, ideas,
culture, etc.) was finally on the upswing in 2006-2007, which would
have dampened or maybe completely swamped the sluggishness in the
real estate market.
The CRA argument is also B.S. The CRA only applies to
federally-insured deposit institutions, not non-banks. The banks
covered by CRA have much lower default rates, and issued far fewer
risky loans. In fact, because the CRA made vanilla mortgages from
banks available in places where they otherwise would not have been,
it served to reduce the number of risky, dumb loans people took out
in CRA-covered neighborhoods.
Mo,
Maybe. You raise some good points.
|9.23.08 @ 2:05PM|#
The number one underlying cause of the financial mess was
the federal reserve creating a real estate asset bubble by pumping
up the money supply, driving down interest rates and devaluing the
dollar.
Other culprits include Fannie Mae and Freddie Mac
So in other words, when non-banks made all sorts of risky loans,
and then packaged them as foolish securities, monetary policy made
them do it.
When Freddie and Fannie engaged in comparable behavior, it was all
their own responsibility.
Sure, that makes sense, Gil.
robc|9.23.08 @ 2:18PM|#
joe,
When private banks make risky loans, they are only risking
themselves and their shareholders money. When Fannie/Freddie do it,
with their guarantee, they are risking everyone's money.
At least that was the theory. But Im okay with letting them all
fail.
kinnath|9.23.08 @ 2:19PM|#
The underlying cause of the current problems is greed.
If you're a progressive, you believe government should impose rules
to prevent greed from leading to crises.
If you're a libertarian, you believe greed should be punished by
the market.
The details are mostly irrelevant.
|9.23.08 @ 2:19PM|#
Everyone in the industry acted in the belief that the GSEs would be bailed out by the government. How much that contributed to the bubble is an open question, but zero would be the wrong answer.
TallDave|9.23.08 @ 2:25PM|#
that would mean J.P. Morgan could not have bought Bear
Stearns, Bank of America could not have bought Merrill Lynch,
Barclays could not buy most of Lehman, and Goldman Sachs and Morgan
Stanley could not become bank holding companies. It is hard to
imagine how things would have worked out in that situation, but it
surely would not have been an improvement.
Sigh. Yes, obviously in the short run, for this relatively small
problem, it helps.
The danger is this: what if in a few years, there's a problem so
big it drags down the banks too? If the government has to bail out
all the FDIC-insured accounts, it's going to be very very ugly.
Think Zimbabwe ugly.
FDIC insurance means that the investment banks are now playing with
taxpayer-guaranteed funds.
Gilbert Martin|9.23.08 @ 2:33PM|#
"So in other words, when non-banks made all sorts of risky
loans, and then packaged them as foolish securities, monetary
policy made them do it.
When Freddie and Fannie engaged in comparable behavior, it was all
their own responsibility."
Next time, try arguing against something I actually said - which
was that federal reserve generated real estate bubble was the main
cause of this mess - and that is true. If there had been no run up
in real estate there would have been no rush to make loans to begin
with.
Nor did I say that there was no responsibilty for it from financial
institutions such as Countrywide. There are multiple factors that
play into it.
As for Fannie and Freddie, they were enablers of the explosion in
subprime loans because not only did they buy loans directly and
securitize those loans themselves, they also bought a bunch of the
loan backed securities that had been created by other financial
institutions. That allowed the other institutions to free up
capital to generate even more loans. And Fannie and Freddie were
operating with an implicit (now explicit) guarantee of government
backing. Those entities were creations of government in the first
place and could never has existed in the market without the
advantage of implicit government backing.
Max D.|9.23.08 @ 2:35PM|#
I see nothing but support for a bailout--even from The Heritage Foundation (WTF?). Can someone explain WHY a bailout is necessary?
|9.23.08 @ 2:36PM|#
The number one underlying cause of the financial mess was
the federal reserve creating a real estate asset bubble by pumping
up the money supply, driving down interest rates and devaluing the
dollar.
Don't worry though, cuz a "new establishment" of financial leaders
that includes people like Paulson, Bernanke, Tim Geithner, Robert
Rubin and Paul Volker are gonna step up and lead us out of this
mess.
David
Brooks told me so, and with those outsiders taking the reigns
we are gonna be all right.
|9.23.08 @ 2:38PM|#
Other culprits include Fannie Mae and Freddie Mac and the
"Community Reinvestment Act"
Yet another person spouting nonsense about the Community
Reinvestment Act.
The CRA didn't require that lenders lend money to people who don't
have the ability to repay. It didn't require anyone to lend money
to anyone. It just forbid redlining neighborhoods.
kinnath|9.23.08 @ 2:40PM|#
I don't understand why progressives aren't mad as hell with Fannie 'n' Freddie. Not only did they fail to prevent greed from leading to a really big fucking crisis -- they were complicit in fanning that greed.
Hmmmmmm|9.23.08 @ 2:43PM|#
And if we hadn't invaded Iraq, we wouldn't have been able to
fight al Qaeda in Iraq.
Bad analogy. We removed Saddam, and AQ and Shia militias (both of
whom already had some presence there) filled the gap. Then we and
the new Iraqi security forces defeated those, and now Iraq is
better off than it has been in decades, probably since their last
parliamentary democracy was ended.
|9.23.08 @ 2:44PM|#
Next time, try arguing against something I actually said -
which was that federal reserve generated real estate bubble was the
main cause of this mess - and that is true. If there had been no
run up in real estate there would have been no rush to make loans
to begin with.
Answered at 2:04. You must have scrolled past it. To sum up, we've
had bubbles pop before, no big deal, and in this case, the drop in
the real estate market would have been largely attenuated by the
growth in the rest of the economy, if the capital markets that
invest in the rest of the economy hadn't been dragged in by
MBSs.
Nor did I say that there was no responsibilty for it from
financial institutions such as Countrywide. There are multiple
factors that play into it. OK. You omitted them from your
previous list.
As for Fannie and Freddie, they were enablers of the explosion
in subprime loans because not only did they buy loans directly and
securitize those loans themselves, they also bought a bunch of the
loan backed securities that had been created by other financial
institutions. That allowed the other institutions to free up
capital to generate even more loans. Agreed. They should not
have been buying crappy loans or crappy derivatives, and their
doing so helped make this problem bigger.
|9.23.08 @ 2:50PM|#
On the Community Reinvestment Act:
The CRA only covers federally-insured deposit institutions, ie,
banks. The bank loans that were given in redlined neighborhoods
have lower default rates than the non-bank loans. Which makes
sense, because the banks provided a far smaller % of risky loans
than the non-banks.
If the CRA was causing dumb loans to be made, we'd expect to see
institutions covered by the CRA to be more deeply involved in this
crisis than CRA-exempt institutions. What we're actually seeing is
just the opposite.
In fact, by making boring loans with such arcane conditions as
"down payments" and "fixed rates" and "affordability standards"
more available in poor neighborhoods, the CRA had the effect of
squeezing risky, non-bank loans out of the market.
|9.23.08 @ 2:57PM|#
There's blame galore in this mess, but one thing I think is
worth noting is that the desire to ensure that everyone had access
to (relatively) cheap credit, combined with the use of the
regulatory hammer to ensure that credit was made available to most
at a capped rate, had a lot to do with creating the disaster. Of
course, even people who could afford credit went crazy, buying more
house that they could afford, which made the problem worse.
I think we always take a big gamble when we move from using
regulation to limit bad action and to promote disclosure to using
it to create some preferred social end result. Incidentally, though
this sounds like I'm blaming the left, I'm not. Both parties have
encouraged this sort of ill-conceived meddling.
robc|9.23.08 @ 3:01PM|#
kevin,
How would eliminating the mark-to-market rules stave off the
collapse?
As I understand it, the "market" value of a lot of these subprime
derivates and etc are at about 22% of full value. Obviously, they
arent worth full value. Also, obviously, the value if you just
foreclosed and sold all the property is worth more than 22%.
However, there isnt really a market for these things and what
market there was has dried up as no one really knows how to value
them and doesnt want them on their books with the mark-to-market
rules.
If these things were valued at say 60% instead of 20%, the owners
would have much higher assets on their books and wouldnt be facing
the liquidity crisis that is driving them under. It would still
suck, but they would be able to ride out the next few years and
hope the housing market finally bottomed out, settled down and a
better market value would exist for these assets.
That is my understanding. It could all be bullshit, I claim to be
no expert on mark-to-market rules.
kinnath|9.23.08 @ 3:28PM|#
Of course, the cynic says that any system put in place to regulate greed, will itself be corrupted by greed.
|9.23.08 @ 4:07PM|#
Joe, Mo addressed a lot of my thoughts previously, but there are
a few points that I would like to add that others have also touched
upon.
The issuance of mortgage backed securities correlates very well
with lower interest rates, the former having peaked in 2003 as the
latter was reduced to record lows by the Fed. Interest rate
influences are by far a more powerful driver than the removal of
regulations which were never meant to prevent such a crisis, and
the data suggests just that. The now failed investment banks still
would have taken advantage of the record number of home loans made
possible by lower rates, by buying and selling in a record number
of MBSs.
And if there was any policy or agency that acted as a driving
force, it was Fannie and Freddie. Implicit guarantees has already
been mentioned a multitude of times, and should not be ignored.
But, more importantly in my mind, these were agencies whose
chartered purpose was to make home ownership more available. Why
would we be so surprised that they were successful in their
efforts? Their purpose was not the prevention of housing bubbles.
They were monstrosities and perversions of the market meant to
achieve a supposedly desirable social end. This is not a child of
the free market. There is a very good reason why the bubble was not
in widgets.
If GS had a marginal effect, it was just that, marginal. Heck, even
as a libertarian, I can say that deregulating irresponsibly is not
advisable. And deregulating is not necessarily a preferable end in
itself. But GLB did not cause this crisis, and GLB was not
irresponsible deregulation. Progressives that keep pointing this
out need to offer more corroborative data than the fact that a
banking deregulation act having passed at some point before this
crisis.
But I am surely bewildered at how any progressive can look at this
data and honestly shout "OMG Free Markets!" (not suggesting that
you are doing this at this moment). Craning your neck around the
elephants in the room (Fed policy and government policy regarding
home ownership) to assign blame to the free market sitting in the
corner is not an appropriately honest analysis. While a good case
can be made for regulation in the home lending industry and of
F&F, the cows have already escaped the barn, closing the doors
will solve nothing regarding the current problem.
And that's the fundamental problem with regulation, it tries to
solve problems after the damage has been done. That is because the
finance industry, like technology, worked much more quickly than
the government could/would/should legislate or regulate.
No administration would have stopped this bubble. Not Bush. Not
Clinton. Not Bush the Wiser. Not Reagan. Not Carter. Not Ford. Not
Nixon. Not LBJ. It is politically untenable to try and do so, and I
would guess that you know that. But maybe I'm wrong about
that.
We, progressive and libertarians alike can find common ground here.
That there is a fundamentally disturbing problem with our system,
that neither regulation nor deregulation will solve. Regulation
will put bandaids on the patient, but it may hemmorage again
elsewhere. Deregulation may only reopen the wound. At some point,
we have to administer the medicine.
/end rant
|9.23.08 @ 4:13PM|#
I also agree that the CRA had no effect, or at worst a marginal effect, in this crisis. This is the analagously ridiculous meme from the right and libertarian circles that is simply supported by little evidence.
|9.23.08 @ 4:15PM|#
"If you're a progressive, you believe government should impose
rules to prevent greed from leading to crises."
Actually, all progessives I know believe government should impose
rules to mitigate the effects of negative externalities. As with
many things, the devil is in the details.
"How would eliminating the mark-to-market rules stave off the
collapse?"
mark-to-market is assigning a value to a financial instrument based
on its current market value. Many of these financial instruments
which are causing the problems never were marked to market, i.e.,
the buyers and sellers had no idea what their value was were the
transaction to be held on the open market. So, they had to
mark-to-model which means they had fancy computers with all kinds
of pricing models based on different variables, assumptions and
imputations. When one of these mark-to-model financial instruments
finally does hit the marketplace, then all holders of identical or
similar instruments must reprice these assets to the market price.
I see nothing wrong with this practice as it is based purely on the
most recent market-based information. I'm no expert on this as
well, but I believe this is an accurate description.
Gilbert Martin|9.23.08 @ 4:59PM|#
Another culprit in this mess that I forgot to mention earlier were the credit rating agengies like Moody's and Standard & Poors who assinged AAA ratings to securites backed by pools of risky loans.
|9.23.08 @ 5:00PM|#
with those outsiders taking the reigns we
are gonna be all right
Typo of the fucking year.
|9.23.08 @ 5:01PM|#
Gilbert Martin is correct as well. AAA, junk bond, what's the difference? Apparently, not much. If something is difficult to value or has a massive downside, how about rating it lower?
|9.23.08 @ 5:09PM|#
DDP,
The Mo abides.
lupan,
The problem is a lot of these instruments are like snowflakes. No
two has the exact same set of mortgages, so they're being compared
to similar (though not sure how similar) instruments. Also, they
can hold them as they pay off and they're worth more. It would be
as if the bank required you to give them your house if your net
worth went below $XXX thousand dollars. Then your neighbor's house
gets forecloses, the bank sells if for nickels on the dollar and
says that because you have a similar house, your house is also
worth nickels on the dollar and you need to hand over your house.
Now, you know and the ank knows that the value will bounce back,
which is why you're holding on to it. Same here.
|9.23.08 @ 6:22PM|#
Mo,
I'm no expert on MBS's, but I agree that no two has the exact same
set of mortgages, but they were supposed to have been pooled
according to similarity in risk profiles, like individual credit
risk scoring like FICO. Now, we can all argue about it's individual
accuracy, but the market has determined that this is the most
accurate measure in the aggregate. So, I have to respectfully
disagree with your analogy. If my neighbor forecloses, the value of
my house will drop, but it has no effect on the risk profile of the
pool of MBS's which my mortgage is already in. That individual
foreclosure would only have an effect in the pool of similarly risk
profiled MBS's it is in, but the effect is only felt as numbers of
foreclosures (or delinquencies IIRC) rise to certain levels. But
MBS's are only a part of the current problem...from what I
understand CDO's are the immediate crisis. CDO's are unregulated
asset backed securities. They aren't only backed by mortgage
assets.
Czar|9.23.08 @ 9:10PM|#
Of course, the cynic says that any system put in place to
regulate greed, will itself be corrupted by greed.
That's not cynical, that's just true. The moment you give someone
authority to regulate who makes a profit you've made it profitable
(and in our country's messy history often necessary) to bribe the
regulators. Since the position of regulator is political, you've
made it profitible for large groups of the financial elite to grab
as much power as possible through political means because holding
those positions means 1) getting rich via others' bribes and 2)
getting rich by favoring your social circle. Voila, market
regulation leads to the vast and irreversible corruption of our
political system by both major political parties, who do their
damnedest to keep anyone else from getting their fingers near the
pie.
There's absolutely no way to correct the problem without taking
away the government's ability to determine who makes a profit,
which probably means a complete Constitutional rewrite.
|9.23.08 @ 9:19PM|#
DDP,
"And that's the fundamental problem with regulation, ..."
Interesting posts, and I can go along with mark-to-market rules
being part of the problem here.
But I would argue that GLB, as well as the CFMA were irresponsible.
They contributed to the current mess by reducing transparency in
securities, allowing savings, investment, and insurance banks to
merge into giants, and even enabling CDS trading to exist. Hell,
the CFMA engendered the Enron debacle.
Throwing out (or not enacting) sensible regulation because it
solves yesterdays problem is a silly argument. Yesterdays problem
has a way of becoming tomorrows.
I'm all for free markets, but proper securities regulations are a
backstop against fraud. Clever criminals are always inventing new
ways to defraud people, but that doesn't mean we should give up. As
long as corporate directors are not personally liable for corporate
fraud, one can't assume that corporations are always rational
actors in the marketplace.
Gilbert Martin|9.24.08 @ 8:34AM|#
Ha ! the greatest Ponzi scheme on earth is the social security
program.
All this bailout stuff is a street corner shell game compared to
that.
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