Tuesday, September 30, 2008

Talking bailout blues

Tina Fey and a number of commentators have poked fun at Sarah Palin's response to Katie Couric's question about the economic bailout. Palin's answer was indeed a meaningless set of platitudes, poorly delivered.

But which of the other candidates has said anything that makes more sense? The Obama/Pelosi argument that the crisis is a function of deregulation and tax cuts makes little sense. In hindsight, one can always imagine a set of regulations that would have prevented any mistake because you can say that we ought to have had a regulation that said "Don't make that mistake." But, in this case, the required regulation would have required the tightening of lending standards. Who, pray tell, would have been pressing for that? Certainly not the Democrats. They were exerting pressure in the opposite direction and that is their guilt in this thing.

Just what was it that we saw yesterday? In this grand bipartisan moment, Nancy Pelosi decides to make a highly partisan and muddlebrained speech. Some have argued, with some justification, that a speech ought not to have caused Republicans to vote against the bill, but that's an oversimplification. Everyone agrees that there are majopr problems with the bill and, for many Republicans (and not a few Democrats) voting for it required overcoming very legitimate objections in the interest of getting some thing done. It's not as if everyone thinks the bill was a wonderful bit of legislation that will definitely fix the problem. Under those circumstances, you do not, as they say in German, "spucken in der Suppe."

Yet that is precisely what Pelosi chose to do and she is too smart not to have done it intentionally.

John McCain says that bipartisanship is hard. In this instance, it may be impossible.

Some type of action is necessary, but I wonder whether we ought to be purchasing anything. Why not lend money to undercapitalized investment houses and banks demanding the status of a preferred creditor with some vary basic proscriptions on what the infused cash could be used for? Loosen the mark to market rules and let the market dispose of the questionable paper.

19 comments:

AnotherTosaVoter said...

First!

Makes one wonder why anyone supports either party anymore.

Nothing but partisan talking points and finger pointing.

Why do you support partisanship, Rick?

John Foust said...

The groupies?

Anonymous said...

For all those Republicans--sometimes the truth hurts, doesn't it? Too bad they couldn't put their hurt feelings aside for the good of the country. But alas, like any true Republican, it's all about them first, their lobbyists second, big corporations third, and somewhere way on down the line, country.

Anonymous said...

I don't support any political party any more; this mess is an illustration of that. I support persons, candidates, but not parties.

Regarding the role of regulation or malregulation in this mess, the head of the SEC put at least part of the blame on regulatory schemes last Friday.

There are no simple answers to this problem, and nearly everyone missed the warning signs. Even economists can't agree on what to do.

Which reminds me of something I heard attributed to Eisenhower: If you took all the economists in the world and laid them end-to-end, they still wouldn't reach a conclusion.

sean s.

gnarlytrombone said...

the required regulation would have required the tightening of lending standards

No, it wouldn't have. It would have required:

1) A recognition that the primary driver of lower lending standards is overly ample aggregate liquidity. Behold. Don't talk to the Democrats about that one. Talk to John Galt.

2) Higher capital and provisioning requirements (i.e., preventing financial institutions from financing speculation by leveraging up to their eyeballs).

3) Maturity mismatch regulations.

4) Either require credit default swaps to be traded on an open exchange, or require financial institutions to purchase federal bailout insurance.

Anonymous said...

One of my favorite blogs is Freakonomics. Google it. Yesterday they posted this interesting article from 1999:

“Fannie Mae Eases Credit to Aid Mortgage Lending”

check out: http://freakonomics.blogs.nytimes.com/2008/09/30/in-the-beginning/#more-3125


sean s.

gnarlytrombone said...

That's beautiful, Sean. Not only do we not have to worry about causation, we can dispense with that pesky correlation as well.

All we need now is boldface names, which makes Cindy Adams the most
perspicacious pundit in the known universe.

Anonymous said...

gnarlytrombone;

I sense that I should reply to your comments, but I can't tell where they are coming from or whether you are agreeing or disagreeing with something I may have said. Perhaps the point of your comments was clear to you; it isn't to me.

The chart is nice. But I remember the old line about "lies, damned lies, and statistics".

It was helpful to include a link to Cindy Adams because otherwise I don't know who the heck she is; I'm still not clear on why I might care who she is.

If there's a point you were making, perhaps you could state it more plainly for me. I used to be young and stupid, but I'm not young anymore.

sean s.

Rick Esenberg said...

GT -

Maybe. Certainly high amounts of liquidity depressed returns and pressure to get money out the door and short term rates were really low. But all of that would have made it harder to get a home loan and I don't see that there would have been much support for that. Certainly we saw what happened when the Bush administration and some Republicans wanted to rain in Fannie and Freddie. It was DOA.

gnarlytrombone said...

Sorry. I'll cut the glib. Here's my case:

- The Freakonomics dude provides zero evidence that the factoid he dug up even correlates with the decrease in lending standards, much less caused them.

- The chart shows that standards began to decline rapidly in 2001-2002. There wasn't a corresponding spike in Fannie/Freddie lending, suprime or otherwise (in fact, the GSE's backed off the market during the period in question and didn't dabble significantly in subprime until 2006, when the pyramid scheme was falling apart - proving their stupidity but not their culpability for the trend. They weren't trying to serve the underserved - they were trying to get a piece of the action and win back market share.

- The sharp decline in standards and the sharp increase in mortgage supply/demand correlates perfectly with the Federal Reserve rate cuts. This is not surprising, given that Greenspan said repeatedly that his goal was to pump up the housing sector to give tech bubble investor refugees a place to land.

- Thus we can reasonably conclude that decline in lending standards was not in response to mandates to serve underqualified borrowers.

The incentive was to take advantage of the extremely profitable arbitrage opportunity between the Fed rate and mortgage loan rates. Subprime loans were even more attractive because the spread was even greater - twice or more as much as traditional loans.

Anonymous said...

gnarlytrombone;

Ah. My purpose (I can't speak for Freakonomics) is found in the fact that the linked news story was dated 1999 and that the Democrats were reportedly pressuring Fanny and Freddie to lower their lending standards. This goes to the charge that Republicans are to blame for our current mess. To the extent that subprime lending practices contributed to our current problem, the Democrats share culpability. I suspect that's why someone dug up the old story in the first place.

I.E: ain't no one innocent.

The other point is that these actions contributed to the problem, not caused it. I doubt there is any one thing that "caused" our problems. You present an analysis of potential causes which I cannot dispute; you may be right. But considering that lots of Very Bright People missed all the warning signs, the case for a specific constellation of causal factors or events is not yet complete. Your arguments are persuasive, but then I am too ignorant to vouch for them.

sean s.

gnarlytrombone said...

I would put it this way. Fannie and Freddie were a problem in their own right. They were poorly managed, corrupt (the reason they backed off the market is chiefly because of accounting scandals) and their relationship with congressional Democrats was/is perverse.

That said, they were incidental to this crisis. They were small players in the high-profit/high risk sector even at the peak (IMO the "serving the underprivileged" mantra was rhetorical cover for a desire to play with the investment banks in a profitable and growing market). Their failure was less about exposure to subprime than the overall weakening of the whole housing sector (in which they were overexposed by 2007).

The growing narrative that the market was forced by bleeding heart liberals into making risky loans just doesn't fly. The market embraced risky borrowers because they were profitable. Consider Lehman Brothers. It was under no legal obligation to enter subprime (and was subject to no supervision), yet went out and bought its own mortgage brokers to rake up $50 billion in subprime securities.

It sounds counterintuitive that lending to poor people would produce the highest returns. But Lehman et al thought they had it figured out. Their computer models said they could balance on the razor's edge, sucking just enough out of subprime borrowers' equity (generated by rising home prices) without sucking them completely dry. And the more loans they made, the higher property values went.

They thought they had invented a stable pyramid scheme, just like every other smart guy in history. They also thought their exposure to risk was minimal because of the default swaps, which was a pyramid scheme built on top of a pyramid scheme. But because the swaps were private contracts, and not traded on an open market, no one knew how rickety the whole structure was. It's still not apparent who owes who what. Freakonomics, indeed.

As Markus Brunnermeier points out in this excellent dissection of the crisis (PDF), the collapse of the subprime game wouldn't have been that big a deal (about 2% of the DOW, which happens regularly).

These extracurricular activities in the "shadow banking sector" are really what amplified the carnage and wrecked the market's confidence, and it's where regulation would have helped the most.

gnarlytrombone said...

Oops. Make that Lehman figure $50 billion a year.

Dad29 said...

Gnarly--don't forget Bear, who was in the same game with the same objectives.

Adding credit-default swaps didn't help.

But the largest problem was the SEC's authorization of 30x leverage for those turkeys instead of the historical 12x.

gnarlytrombone said...

Yeah, I was using Lehman as a synecdoche for the whole industry and shoulda made that clear.

I'm convincing myself that the default swaps were the keystone in the whole crazy scheme. It was a license for self-delusion, if not outright fraud. There's been conjecture that Lehman was selling swaps to itself. The scheme is so byzantine I can achieve zen consciousness just thinking about it.

Dad29 said...

I can achieve zen consciousness

Yah--and the guy who thunk it up was in some sort of altered consciousness, too...

AnotherTosaVoter said...

Dad,

And that's different from every other religion, how?

Terrence Berres said...

"There's been conjecture that Lehman was selling swaps to itself. The scheme is so byzantine I can achieve zen consciousness just thinking about it."

Sounds like a Lehman bailout would have been a one-hand-clap sandwich.

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