It's the moral hazards

[wufwugy]

It seems my role on this board (the other board, duh) is to say something about economics that you guys hate then get pounced on and eventually retreat because I'm not looking for a big argument. The board has no shortage of smart people, but it does have a shortage of certain perspectives and information. I know few agree with that -- I didn't until after I wandered elsewhere. Regardless, my goal is not to present an argument and successfully defend it (I couldn't, because I'm not an expert), but to occasionally make a point that doesn't get made and hope that others will tuck it away or investigate. The latest is countering the mainstream view that the housing crisis was a result of greed. I use to believe that argument through and through, but over time am seeing that it doesn't stand up well to the data and doesn't make much sense. Anyways, here's a good source that details the moral hazard role in creating the crisis

http://www.businessinsider.com/the-cra-debate-a-users-guide-2009-6

If you think the perspective is wrong, cool. I don't have near the level of expertise to argue with some of you, but there is absolutely a chunk of people with much higher expertise than anybody here who completely disagree with the mainstream view, and I just want to make sure that perspective gets its play

 

[Petrel]

I'm not sure I understand this perspective. Did they say government legislation forced banks to lend money to people who were a poor risk? Or that banks were encouraged to relax their standards, or allowed to relax their standards? Who made the decisions?

 

[wufwugy]

I'm not sure I understand this perspective. Did they say government legislation forced banks to lend money to people who were a poor risk? Or that banks were encouraged to relax their standards, or allowed to relax their standards? Who made the decisions?

Incentives. When the law regulates something in industry, it creates an incentive for that industry to behave a certain way. That wording sounds like the incentive is meager and thus avoidable, but really it's not because of things like competition. If industry or companies don't react to the indirect incentives of regulation, they pretty much end up losing. This creates a sort of deterministic business environment where industry must adhere to all the moral hazards. Moral hazards apply to virtually all regulations, even ones that solve an important problem.

 

[Petrel]

Yabbut, if the banks thought this regulation was going to hurt them, couldn't they have influenced the Reagan or one of the Bush administrations to change it?
Was it hurting them? I mean, if the regulation incentivizes all the banks to do the same thing, and none of them really want to, where is the competition?

 

[boneyard bill]

It seems my role on this board (the other board, duh) is to say something about economics that you guys hate then get pounced on and eventually retreat because I'm not looking for a big argument. The board has no shortage of smart people, but it does have a shortage of certain perspectives and information. I know few agree with that -- I didn't until after I wandered elsewhere. Regardless, my goal is not to present an argument and successfully defend it (I couldn't, because I'm not an expert), but to occasionally make a point that doesn't get made and hope that others will tuck it away or investigate. The latest is countering the mainstream view that the housing crisis was a result of greed. I use to believe that argument through and through, but over time am seeing that it doesn't stand up well to the data and doesn't make much sense. Anyways, here's a good source that details the moral hazard role in creating the crisis

http://www.businessinsider.com/the-cra-debate-a-users-guide-2009-6

If you think the perspective is wrong, cool. I don't have near the level of expertise to argue with some of you, but there is absolutely a chunk of people with much higher expertise than anybody here who completely disagree with the mainstream view, and I just want to make sure that perspective gets its play

If the mainstream view is that the housing crisis was caused by greed then it is surely wrong. If greed caused financial crises, we'd be having one every day. Saying that greed caused the crisis is like saying that gravity caused that guy you pushed off the top of the Empire State Building to fall and die. Yes, gravity was a factor because its a constant. Sure greed was a factor because greed is a constant in virtually all financial transactions other than outright gifts and even there greed is factor if the gift is large enough that the government wants a share of it.

As for the CRA, the author makes a great case that it was the reason why we had a real estate bubble rather than a bubble somewhere else. But the fact is that Greenspan lowered interest rates from 6.5% in 2000 to only 1% a few years later. Well guess what. When you lower interest rates you shouldn't be surprised when people borrow more money. The CRA made it especially attractive for banks to push low-interest rates and easy lending standards for real estate, but the low interest rates pretty much guaranteed that more money would be lent, and that it would have created a bubble somewhere, with or without the CRA.

 

[boneyard bill]

Yabbut, if the banks thought this regulation was going to hurt them, couldn't they have influenced the Reagan or one of the Bush administrations to change it?
Was it hurting them? I mean, if the regulation incentivizes all the banks to do the same thing, and none of them really want to, where is the competition?

Trying to change a civil rights law is not easy these days. The banks and the Reagan administration would have been attacked unmercifully. It's far easier just to get these administrations not to enforce it too strictly, and that's exactly what happened according to the article. It wasn't until the Clinton Administration began tougher enforcement that it became a potential factor, but even then it didn't trigger a lot of lending because money was relatively tighter. But couple tight enforcement with an easy money policy and suddenly it becomes a big factor. And the second Bush Administration wouldn't go back to loose enforcement because they were pushing for more housing sales as part of Bush's "Opportunity Society."

 

[wufwugy]

Yabbut, if the banks thought this regulation was going to hurt them, couldn't they have influenced the Reagan or one of the Bush administrations to change it?
Was it hurting them? I mean, if the regulation incentivizes all the banks to do the same thing, and none of them really want to, where is the competition?

It's very hard to identify problems specifically, proactively, and to get them changed. Many people don't even view many problems as problems. We tend to have a very moralistic view of the economy, but as I keep trying to point out, economics doesn't care about our morals. It doesn't care that we think things like "housing should be affordable", and it will naturally respond to the regulations set up to do that, for good or bad. Economics is a science and does work certain ways. It's just a really hard to understand one (in ways)

 

[wufwugy]

As for the CRA, the author makes a great case that it was the reason why we had a real estate bubble rather than a bubble somewhere else. But the fact is that Greenspan lowered interest rates from 6.5% in 2000 to only 1% a few years later. Well guess what. When you lower interest rates you shouldn't be surprised when people borrow more money. The CRA made it especially attractive for banks to push low-interest rates and easy lending standards for real estate, but the low interest rates pretty much guaranteed that more money would be lent, and that it would have created a bubble somewhere, with or without the CRA.

I think it looks true (and perhaps is true) if the economic framework is Austrian-based, similar to pre-Fed, or the current European central banking view, where "structural reforms" are of utmost importance. But under a paradigm where the money supply is controlled by an institution (or a market) and can smooth out what would otherwise be structural problems, the bubble view breaks down. We see this breakdown in countries like Australia and Canada, whose "obvious bubbles" never popped. Also, the view that interests rates are a good indication of tightness or looseness of money was debunked a long time ago. However, the economics profession did fall back into believing it in the previous decade

 

[laughing dog]

The CRA did not apply to mortgage brokers - who were a significant factor in the origination of the eventually bad mortgages. Nor does the cited OP "analysis" recognize that banks and S&Ls competed with those mortgage brokers. Finally the CRA did not encourage the financial "innovations" of bundling of mortgages and the secondary markets for mortgages .

I find the cited OP argument and its variants rather curious in that they claim that bankers were very risk-averse in dealing with "the regulators" but the same bankers abandoned their risk-aversion when making loans. Of course, that may be due to the fact that banks were off-loading those mortages - which was not forced nor encouraged under the CRA.

 

[funinspace]

I think it looks true (and perhaps is true) if the economic framework is Austrian-based, similar to pre-Fed, or the current European central banking view, where "structural reforms" are of utmost importance. But under a paradigm where the money supply is controlled by an institution (or a market) and can smooth out what would otherwise be structural problems, the bubble view breaks down. We see this breakdown in countries like Australia and Canada, whose "obvious bubbles" never popped. Also, the view that interests rates are a good indication of tightness or looseness of money was debunked a long time ago. However, the economics profession did fall back into believing it in the previous decade

Most of the people I read don’t simply blame “greed” for the housing bubble, they typically blame multiple components. Some even include the CRA into the mix, as I would. At the same time, there were shitloads of pricier homes that were forclosed upon during the crisis that would typically have loans beyond what Freddie and Fannie would allow.

Additionally, when one wants to compare Canada and Australia to the US, one needs to also factor in the other countries tax codes, personal bankruptcy law, and loan limitations. For one thing neither of these countries allows for mortgage interest deductions in their income tax code.

Most Canadian homes have much higher downs, require more mortgage insurance, and are full recourse. And their loan terms are very different:
http://www.american.com/archive/201...canadas-marvelous-mortgage-and-banking-system

2. Shorter-Term Fixed Rates in Canada. Canadian mortgages carry a fixed interest rate for a maximum of five years, and rates are then re-negotiated for the next five years, similar to a five-year adjustable rate. This practice allows banks to achieve a better maturity match between their assets (mortgages and loans) and interest income, and their liabilities (deposits) and interest expense, which protects them from the kind of maturity mismatch and interest rate risk that resulted in our S&L crisis and almost 3,000 bank failures in the 1980s and 1990s.

 

[Petrel]

It's very hard to identify problems specifically, proactively, and to get them changed. Many people don't even view many problems as problems.

Could this perhaps include the loan officers, branch managers and marketing reps who got credit for selling the "product'?

Economics is a science and does work certain ways. It's just a really hard to understand one (in ways)

Like gravity? Has its own rules and is entirely independent of and impervious to human values and decisions?
I have heard a good many economists and bankers say in public: "Nobody could have foreseen..."etc.
And I've heard a few others say, with equal conviction "I warned them this would happen, "
I guess the left invisible hand knoweth not what the right invisible hand doeth.

 

[wufwugy]

Like gravity? Has its own rules and is entirely independent of and impervious to human values and decisions?

I didn't mean it's impervious to human behaviors. It's made up largely of human behaviors

The way I mean that economics "doesn't care about our morals" is analogous to if you're raising your kid under abstinent-only sex education because you think premarital sex hurts Jesus, it won't work because your kid's biology and psychology ultimately doesn't care about moral impositions that distort natural function. If we say "everybody should own a home and we should pass laws to make that happen", we have to acknowledge that the effects of those laws on the economy don't just disappear, whether they're good or bad. If any of the effects are bad and become apparent, a lot of people say "but we did the right thing by getting people into homes". What I'm pointing out is the explanatory style: "the right thing". Economics is systemically amoral, but much of what we think about it and do with it is moral

The most basic example I always go for is the Soviet Union. It was selling goods for cheaper than they cost to make. The country used a paradigm that said everybody gets a job and everybody gets the product from those jobs regardless of costs or prices. This was a moral imposition on a mostly unbreakable economic reality of supply and demand, and it's no wonder the Soviet Union collapsed and was never that prosperous in the first place

 

[Petrel]

The most basic example I always go for is the Soviet Union. It was selling goods for cheaper than they cost to make. The country used a paradigm that said everybody gets a job and everybody gets the product from those jobs regardless of costs or prices. This was a moral imposition on a mostly unbreakable economic reality of supply and demand, and it's no wonder the Soviet Union collapsed and was never that prosperous in the first place

And the wholesale theft, fraud, embezzlement, skimming, nepotism, incompetence, creative bookkeeping, bribery and corruption from the Kremlin, through regional administrators, down to the head of every department of every industry didn't play a part?
And yet, and yet, starting from a near medieval standard, and in the wake WWII damage and Stalin's depredations, they achieved universal employment, healthcare, literacy, post-secondary education for every capable student, first space adventure.... plus an un-frickin-believable military, spy and political control edifice that's still getting exported at a profit.

Just sayin' American banks might have put up more of a struggle against these intrusions if there hadn't been money to be made somewhere along the way.

 

[Loren Pechtel]

I'm not sure I understand this perspective. Did they say government legislation forced banks to lend money to people who were a poor risk? Or that banks were encouraged to relax their standards, or allowed to relax their standards? Who made the decisions?

When the government "encourages" something they often apply a pretty darn big stick to that encouragement.

The CRA was the spark that led to the collapse. I still put most of the blame on Bush, though, because he did nothing while the problem grew and grew.

 

[wufwugy]

And the wholesale theft, fraud, embezzlement, skimming, nepotism, incompetence, creative bookkeeping, bribery and corruption from the Kremlin, through regional administrators, down to the head of every department of every industry didn't play a part?

Of course it did, but that isn't a counter to my point. Regardless of the reasons why, the economy was abysmal because it was selling products and paying wages in a way that were higher resources going out than coming in. Bill Clinton would call the Soviet problem "arithmetic".

And yet, and yet, starting from a near medieval standard, and in the wake WWII damage and Stalin's depredations, they achieved universal employment, healthcare, literacy, post-secondary education for every capable student, first space adventure.... plus an un-frickin-believable military, spy and political control edifice that's still getting exported at a profit.

When compared to its closest relatives, these results are a disaster. People vastly underestimate how much Russia sucks right now. Residents are leaving in droves because the economy is a shithole. It's still a dictatorship where the citizens have no rights. Look at Ukraine. The whole issue that has become the Crimean invasion is because Kiev is so afraid of the disaster that is Russian hegemony

"Full employment" means nothing when that's your only data point. These members of the "fully employed" were having trouble getting the right kinds of shoes. How the West seems to have forgotten how bad communism was (is) just blows my mind. I mean, where in the world is that coming from?

 

[Petrel]

Just wondering whether it's not so much the unbreakable laws of economics as the actual people making the actual killings.

 

[wufwugy]

Just wondering whether it's not so much the unbreakable laws of economics as the actual people making the actual killings.

The killings were part of what broke the economics. If things like relocation and management changes in the farm system made things better for the economy despite the moral problems like deaths, they still would have increased prosperity in aggregate. I'm not saying that the idea of communal economics is wrong, but that an idea that effects into disobedience of basic rules that govern resource creation and distribution is not sustainable.

If we were to find an offshoot of socialism that worked, we would find that it is different enough from Soviet communism to the point that rules of resource allocation are adhered to. Communism tried to defeat supply and demand, and it lost

 

[boneyard bill]

I think it looks true (and perhaps is true) if the economic framework is Austrian-based, similar to pre-Fed, or the current European central banking view, where "structural reforms" are of utmost importance. But under a paradigm where the money supply is controlled by an institution (or a market) and can smooth out what would otherwise be structural problems, the bubble view breaks down. We see this breakdown in countries like Australia and Canada, whose "obvious bubbles" never popped. Also, the view that interests rates are a good indication of tightness or looseness of money was debunked a long time ago. However, the economics profession did fall back into believing it in the previous decade

I think you have it just backwards. When an institution controls the money supply, it can create a bubble. It's much more difficult for a bubble to occur in a free market. Likewise, in a free market low interest rates would merely indicate a surplus of savings, not necessarily loose money. But in a fiat money system run by a central bank, low interest rates are basically achieved through loose money policy. In fact, the terms are almost synonymous since it's pretty much a unitary process. Of course, once inflation gets going, then nominal interest rates will rise to cover the inflation rate but real interest rates will still be low.

I don't know what you are referring to in Australia and Canada. Bubbles are sometimes easy to detect and sometimes not, but if they didn't pop, there's a good possibility that they weren't bubbles in the first place.

 

[wufwugy]

I think you have it just backwards. When an institution controls the money supply, it can create a bubble. It's much more difficult for a bubble to occur in a free market. Likewise, in a free market low interest rates would merely indicate a surplus of savings, not necessarily loose money. But in a fiat money system run by a central bank, low interest rates are basically achieved through loose money policy. In fact, the terms are almost synonymous since it's pretty much a unitary process. Of course, once inflation gets going, then nominal interest rates will rise to cover the inflation rate but real interest rates will still be low.

I don't know what you are referring to in Australia and Canada. Bubbles are sometimes easy to detect and sometimes not, but if they didn't pop, there's a good possibility that they weren't bubbles in the first place.

That's right, they're not bubbles in the first place. They look exactly like smaller "bubbles" that have already "popped", but they're not "popping" because the bubble concept is not accurate. This much should be obvious since bubbles are only declared retroactively. It's basically religion. Captain Hindsight is not science

Monetary experts do not agree with your view of interest rates and looseness/tightness of policy.

The data shows that central banking and monetary manipulation has been able to thwart "bubbles" and their "popping" by smoothing NGDP growth and that a lack of monetary manipulation makes "bubbles" and their "popping" all over the place. There's a reason why the 19th century was rife with skyrockets and collapses and structural rebalancing, and there's a reason why modern economies with well-functioning central banks (*cough* Australia *cough*) are performing better than virtually any other economies on record and they don't have any bubbles or any pops

 

[wufwugy]

I should add that if low interest rates were a sign of loose policy, we would be seeing very high inflation now. Nevermind that the notion was debunked a long time ago, but we've had low interest rates now for so long that this is a fantastic test of what they mean about tightness/looseness of policy. The fact that inflation has not ramped up while interest rates have been chronically low demonstrates that monetary experts have been right all along and low rates do not mean money is loose.

People were crying hyperinflation back in 09 because of the low interest rates and monetary base expansions. These people now need to accept that they were wrong. Sub-2% inflation over the last several years is a categorical demonstration that policy has not been loose