Thursday, September 18, 2008

Maybe the government did cause the financial crisis - through regulation

I've blogged about the fact that Obama is talking nonsense on the financial crisis. McCain wants to undertake a thorough study of its causes and Obama ridicules the idea. We know how we got into this mess, he says, we need the change that will get us out.

But he has offered neither a diagnosis or a course of treatment. On the cause of the problem, he essentially offers two arguments. The first is that there is some kind of culture of greed created by George W. Bush and John McCain. This is unworthy of anyone who has even walked across Harvard Yard. We've had giant businesses collapse either due to speculation or misstatement of their financial condition before. Enron did not begin its skullduggery on January 20, 2001. The tech bubble occurred during the Clinton era, etc.

The other argument is that there was some culpable deregulation during the Bush administration but I've yet to see an explanation. In fact, there was a monumental increase in regulation called Sarbanes-Oxley and, although it did not pass, John McCain co-sponsored a bill that would have increased regulation of Freddie and Fannie. Obama did not co-sponsor that bill.

McCain's current rhetoric is only marginally better. He is blaming corruption and greed and no doubt we had some of that, but the real causes are probably more complicated that and may not fit comfortably into the narratives of the right or left.

There is a fascinating article by Zachary Karabell in this morning's Wall Street Journal. He starts with something that has puzzled me. The housing market is down, but it's not that bad. There is an increase in foreclosures but the percentage of mortgages in foreclosure and default is still very small. Why would a significant, but noncatastrophic decline, lead to a catastrophe?

Karabell argues that it is a result, not of Bush era deregulation, but of Bush era regulation, in particular, the "mark to market" rules dictated by Sarbanes-Oxley. As explains it, SOX reguired that a company's assets be revalued quarterly as if they were to be immediately sold. If there would be no buyer now, then the value is zero.

This is hyperconservative. One doesn't sell when the market is down and today's price may not reflect long term value. But if the assets must be written down, the balance sheet - and the company - collapses.

This was an unintended consequence. Karabell is not arguing for no regulation (he makes the point that no regulation at all means no market), but for good regulation and for the need for regulators not to overreact to the most recent problem.

How powerful is Karabell's explanation? I don't know but it seems like a serious effort to address the problem, albeit one that doesn't fit the narrative of our political campaigns.


Dad29 said...


SOX created some problems, but leveraging 30x is still...inane.

However, it IS true that FDIC is forcing banks to write off/write down a number of PERFORMING loans--i.e., payments are being made, covenants are being kept, etc.

It's "SOX-lite"--no law, just regulatory decisions.

This has an effect: the banks are unwilling to write loans which FDIC will (post facto) declare 'uncollectable.' And since bankers are puzzled by FDIC's standards, they simply retreat to 'no-loans' as policy.

Anonymous said...

the percentage of mortgages in foreclosure and default is still very small

So was the ratio of hemlock to Socrates's daily fluid intake.

Anonymous said...

The last estimate I heard of mortgages in default/foreclosure was somewhere in the vicinity of 5%. While not great, this level should not be bringing about worldwide financial catastrophe. There are obviously other factors influencing all of this.

A different perspective... If public schools were graduating 95% of students successfully - wouldn't that be construed as an enormous positive? Would everybody be hyperventilating about the world collapsing?

Too bad that in the 24/7 news cycles and the complication of a presidential election cycle, we can't just stop and take a deep collective breath for a moment and analyze all of this without emotion.

Anonymous said...

While not great, this level should not be bringing about worldwide financial catastrophe

Other than the notion that 5% (it's 9.2% according to the Mortgage Bankers Assn.) "seems" like a "small number," what is this assessment based on?

Dad29 said...

The problem is not exclusively 'the % of foreclosures.'

The problem is that nobody knows what the COST of those foreclosures will be. I.E., will the banks take a 10% haircut? 20%? 30%?

It could be zero, and it could be 50%.

Uncertainty is what's driving the market.

That, and 30x leveraging.

Anonymous said...

Why were Freddie and Fannie being run by liberal cronies of Clinton?
Why were Johnson and Raines made multi-multi-multi-MILLIONAIRES by virtue of their political CONNECTIONS to Bill Clinton.
Why did Jamie Gorelick make millions and millions?
Why did Obama hire Johnson and Raines?
Lastly has Borat Obama thrown Raines and Johnson under the bus yet?

This is not the Johnson and Raines that I knew!!!"

Anonymous said...

In an WSJ opinion piece yesterday, the former head of the FDIC also points to the "mark to market" rule as one of three primary factors in the current credit crisis, so the rule may warrant some revisiting. (The other two factors he identifies are "naked short selling," which makes some sense and is condemned by my Church in any event, and adoption in this country of the Basel II rules, whatever the hell they are.)

Dad29 said...

Doctrinally, you are only half right.

Under Church teaching, one may sell shorts.

However, one may not be NAKED and sell shorts.

Subtle but significant difference.

Anonymous said...

The problem was that we can never trust anyone to gamble with securitized mortgages. What the government is proposing now is fascism, plain and simple, and it seems only conservatives are noting this. For a historical perspective and penetrating critique, see The New New Deal: A Public-Private Partnership Called "Fascism" at

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