The Economist's 2009 Consensus Lunacy Tour


If you're like me, the phrase "18-Page Special Report in The Economist" is just slightly less chilling than "positive result on your biopsy." Nevertheless, if you're interested (still?) in the Great Credit Unwind, take a fistful of Dramamines, zoom on up to High International Neoliberal Orbit — where the people on the ground look like ants and you can pretend you're in smart company because they spell "securitize" with an ess rather than a zed — and enjoy this investigation of the "shadow banking industry." The nameless Author posits that the massive reduction in lending has come mostly from capital market lenders, not banks:

The really precipitous contraction in credit has come from non-bank lenders–the array of money-market funds, hedge funds, former investment banks, exchange-traded funds and the like that is sometimes called the "shadow banking system". These capital-market lenders are especially important in America–banks have supplied only 20% of total net lending in the country since 1993…but they play an increasingly important role elsewhere too.

In particular, non-bank lenders have been buyers of securitised products, loans that are bundled together into securities and sold on to investors. An estimated $8.7 trillion of assets worldwide are funded by securitisation. More than half of the credit cards and student loans originated in America in 2007 were securitised. Many European banks used securitisation to fund the expansion of their loan books in the boom.

The size of the contraction is daunting: A study by a consultancy suggests capital market lending contracted by $950 billion in the first three quarters of 2008, while banks' net lending in all of 2007 was only $850 billion. This seems to me a solution in search of a problem. Having finally squeezed the last plugged nickel out of the last deadbeat, the universe of hot-potato lending is getting smaller, as it should. Banks have been burned in the process, but hedge funds and investment banks have been incinerated, and if anything's clear it is that there were too many of those folks to begin with.

But beware. The Economist's tricky pal "Emerging Consensus" shows up later to explain how the state can solve the moral hazard in which "originators had less incentive to care about the quality of the business they wrote because they thought the risks were someone else's problem. By making issuers take the first loss on any defaults in the securitised pool of assets (and stipulating that they cannot hedge that exposure away), regulators will give them a clear incentive to think about asset quality."

You need a regulator to tell you that? If you're selling me a cluster of questionable debts, and we have both learned that an echo chamber of insurance policies against our mutual defaults will not in fact make us both richer if the original debts go bad, the lesson has already been learned, and you and I will make our arrangements accordingly (and our contract will specify either your taking the first loss, my getting a much higher return, or liberal use of meat hooks and power tools to encourage the debtors to keep paying). I'm not sure the lesson was that tough to begin with. But here's a bet I would take: Regulation that tries to assign responsibility in this way, or forbids the parties from hedging their exposure, will give rise to wider use of even more cockamamie derivative products within a decade.

Toward the end the Author does address the problem of solving a problem that's already solved, and throws in a weird but interesting operational question:

Government intervention in America and elsewhere to ease homeowners' repayment difficulties will shake investor confidence in future income streams. The prospect of court-ordered reductions in mortgage principal-or "cramdowns"-is particularly alarming. According to Anna Pinedo of Morrison & Foerster, a law firm, there is also fogginess around the tax status of securitisation trusts, the entities into which securitised assets are placed. For tax purposes, they are structured as "pass-through" entities, meaning that the servicing firms that administer mortgage payments have little scope to modify the terms of loans if borrowers get into difficulty. With servicers now given greater leeway to intervene, questions about how far they can go without compromising trusts' tax status hang over the industry.

But the real whopper comes at the end, with a science fiction vision of a pangalactic FDIC which will provide "institutionalised guarantees for buyers of securitised assets to sit alongside guarantees for retail depositors." 

I can't think of many ideas worse than a government-backed, or even government-implied, guarantee of securities whose whole point is that they offer rock-star-commando levels of risk. Whole article, with charts.

NEXT: The Housing Boom and Bust

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  1. Or you can pretend to be snooty because you say “zed” rather than “zee.”

  2. The Economist owns you, Tim Cavanaugh.

    Yes, they get stupid occasionally with wishy washy ‘future global world order’ prognostications. They also have a pretty crappy track record endorsing presidents. But the ‘international neoliberal’ label is semi-unfair. They do a SHITLOAD of coverage on a wide range of topics, and only rarely do you get the sense of it being high-minded Eurothink. They endorsed drug legalisation (S bitch!), and did a ‘special report’ on torture well before the Abu Gharib blowup. They shit all over the UN whenever they get the chance. For what its worth, I would say they are closest to a classical-liberal publication of any major news gathering organisation. (ess bitch! no zeds!)

    Basically, The Economist is your daddy. With charts.

  3. I think he was being funny.

  4. OK, so…..

    Lenders moving risks to others via hedging is bad, because it creates moral risk, but risk being moved from lenders to taxpayers via government is just peachy, because The Right People are in charge now.


  5. By Jove, jsh, I think you’ve got it!

  6. A lot of people were disappointed by The Economist endorsing TARP (here). They also seem to have a deference for health care intervention, presumably because it’s working so well on the other side of the pond. Besides that, the newspaper is at least somewhat sensible in its analysis, which is something I can’t say about the NYT at least half the time.

  7. “…pretend you’re in smart company because they spell “securitize” with an ess rather than a zed…”

    Reason Magazine commenting on spelling?

    And also a joke I heard the other day (I’m probably behind the times hearing it):
    “People used to say that a black man would be president when ‘pigs fly’, well low and behold, 100 days into Obama’s presidency ‘swine flu’.”

  8. I like that one, Mango. I like Das Ekonomyst too, I really do! And by “Neoliberal” I actually meant “the thing Eurothink defines itself in opposition to.” Ouch, GILMORE, ya big google-eyed economist softee ya.

  9. As good a place as any to post this…

    Remember those damned speculators Herr Obama bitched about holding up the Chrysler deal?

    Turns out they’re government employees.

  10. On The Economist’s political leanings:

    I consulted the oracle (read: Wikipedia) and found

    Political allegiance: Classical liberalism

    I’ve found the publication to be rather palatable, and besides a couple editorial stunts (TARP, Healthcare) have found the above prognostication holds true.

    *Cue long-winded debate on the hue variations between classical liberalism and libertarianism.

  11. My company was recently bought up by the Economist Group. Since we get issues at the office I read it during lunch when I can stomach it, or at home when I can’t sleep. From what I’ve read its free market advocacy is perceptible enough it’s very clear you’re not reading a typical news periodical, but at the same time so lukewarm as to be rather pointless.

  12. …at the same time so lukewarm as to be rather pointless.

    Ten years ago they took pride in calling themselves “extreme moderates”, meaning classical liberals, now “lukewarm moderate” sounds about right. The shift towards belief in the government being able to solve problems has been quite dramatic.

  13. “I can’t think of many ideas worse than a government-backed, or even government-implied, guarantee of securities whose whole point is that they offer rock-star-commando levels of risk.”

    Here’s an idea that’s much worse: Let everybody fend for him or herself in a completely deregulated, unfettered free market. Just kidding, that’s just too farfetched.

  14. As an avid Economist reader, I was disappointed on their take on the bailout, but I believe its mostly because their writers can get a bit carried away in their own “supposed” expertise, reverting back to technocracy when it comes to certain financial matters, then back to classical liberalism for most other topics. I could easily see them as an “Alan Greenspan” classical liberal rather than a Reason libertarian. Still, given their competition in the magazine business, they stand alot closer to Reason than any of the red or blue mags out there.

  15. Making originators maintain an unhedged risk in the securities works if and only if the primary cause of the systematic underestimation of the risk associated with the securities is originators who know at the time the securities are substantially more risky than the buyers think they are. If the originators share the buyer’s assesment of the risk, all that making the originators keep more of the risk accomplishes is to make originators blow up in a more spectacular way relative to the buyers when serious mistakes are made in pricing the risk, since the originators won’t create any less of them (the underestimation of the risk means making the underlying investment still looks like a good idea), just keep more of them in their own portfolio. The consequences of mistakes will be slightly more contained in terms of affected firms, but it will take relatively smaller ones to hose the companies that are involved.

  16. As a regular Economist reader, I think the problem may be their strong allegiance to the banking and finance industries. Whether its because that’s the bulk of their subscribers or that all their best friends work in the City, the Economist seems to lose their classical liberal perspective when it comes to those industries. Of course, they also seem to have become noticably more liberal over the past decade, perhaps due to staffing changes, which is a shame given the lack of other mags (Reason excepted!) that preach something other than the standard red/blue party lines.

  17. At least they make a profit.

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