Tuesday, May 26, 2009

Deregulation Acquitted Again, Part VII

Niall Ferguson in the May 17th New York Times:
Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis -- or predicted the wrong crisis (a dollar crash) -- have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.

There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans -- who supposedly have much better-regulated financial sectors than the United States -- have even worse problems in their banking sector than we do. The German government likes to wag its finger disapprovingly at the "Anglo Saxon" financial model, but last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.

We need to remember that much financial innovation over the past 30 years was economically beneficial, and not just to the fat cats of Wall Street. New vehicles like hedge funds gave investors like pension funds and endowments vastly more to choose from than the time-honored choice among cash, bonds and stocks. Likewise, innovations like securitization lowered borrowing costs for most consumers. And the globalization of finance played a crucial role in raising growth rates in emerging markets, particularly in Asia, propelling hundreds of millions of people out of poverty.

The reality is that crises are more often caused by bad regulation than by deregulation. For one thing, both the international rules governing bank-capital adequacy so elaborately codified in the Basel I and Basel II accords and the national rules administered by the Securities and Exchange Commission failed miserably. It was the Basel system of weighting assets by their supposed riskiness that essentially allowed the Enronization of banks’ balance sheets, so that (for example) the ratio of Citigroup’s tangible on- and off-balance-sheet assets to its common equity reached a staggering 56 to 1 last year. The good health of Canada’s banks is due to better regulation. Simply by capping leverage at 20 to 1, the Office of the Superintendent of Financial Institutions spared Canada the need for bank bailouts.

The biggest blunder of all had nothing to do with deregulation. For some reason, the Federal Reserve convinced itself that it could focus exclusively on the prices of consumer goods instead of taking asset prices into account when setting monetary policy. In July 2004, the federal funds rate was just 1.25 percent, at a time when urban property prices were rising at an annual rate of 17 percent. Negative real interest rates at this time were arguably the single most important cause of the property bubble.

All of these were sins of commission, not omission, by Washington, and some at least were not unrelated to the very considerable political contributions and lobbying expenditures of the financial sector. Taxpayers, therefore, should beware. It is more than a little convenient for America’s political class to blame deregulation for this financial crisis and the resulting excesses of the free market. Not only does that neatly pass the buck, but it also creates a justification for . . . more regulation. The old Latin question is highly apposite here: Quis custodiet ipsos custodes? -- Who regulates the regulators? Until that question is answered, calls for more regulation are symptoms of the very disease they purport to cure.

16 comments:

OBloodyHell said...

> Human beings are as good at devising ex post facto explanations for big disasters

I believe the term you're looking for here is "ex post fiasco".

:oP
.

OBloodyHell said...

good piece, BTW.

Powerboss said...

It's perplexing...I mean understanding the whole meltdown, it's genesis etc.

What I'd really like to see is you boil this all down into one neat blog post, linking to all your other blogs, as to the main reasons why this collapse occurred.
Leftists blame capitalism and deregulatio, derivatives, etc, etc.
I want to know the genesis, how it happened, why it happened, who let it happen, etc. Can you point to any good articles in this regard?


Penguins Sweep Hurricanes. Bring on Detroit. I'm feeling confident.

bobn said...
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bobn said...
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bobn said...

(Sorry for the deleted comments - Blogger is stealing my white-space after italicized text.)

the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now.This alone is enough to discredit this writer. 1973 - 1975 had no financial crisis - and the current depression is so far from being over it isn't even funny.



The reality is that crises are more often caused by bad regulation than by deregulation.Gibberish. A distinction without a difference when dealing with BushCo, who were "on watch" when the worst happened.



Simply by capping leverage at 20 to 1, the Office of the Superintendent of Financial Institutions spared Canada the need for bank bailouts.Oh, so letting the Big 5 I-Banks (which strangely enough no longer exist in anything like theit previous form) expand their leverage from 12:1 to 40:1 wasn't such a good idea? It came from the deregulation inherent in appointing deregulationists as "regulators".


Sorry Carl: your philosophy is most certainly not acquitted and quoting gibberish like this doesn't help your case.

suek said...

I'm finding this blog helpful, but I also feel very ignorant and not especially qualified to judge.

His position is largely that laws in place to regulate financial dealings have been broken, and no one is making any effort to enforce them. To be honest, I'm not sure they're enforceable - at least in a court of law. Look at how long Enron took. Eventually, it did succeed, but the economics here are so arcane...would a jury understand what the laws entailed, and if they were broken? I wonder...

http://market-ticker.denninger.net/

bobn said...

Blogger has problems I can't work around.

Carl said...

I've tried to provide my take on the issues both here and here. I might attempt more, or respond further to bobn, over the weekend.

OBloodyHell said...

> (Sorry for the deleted comments - Blogger is stealing my white-space after italicized text.)

Yah, it's been doing this for a couple months, now. I've bitched in the right places, but something causing problems for thousands of blogger users doesn't seem to have a high priority.

I've taken to adding a period after any line-ending html markup:

not this.Case in point.
.
.
.
but this.

Case in point.

OBloodyHell said...

The above, the period was outside the [b] tag:

this[b].

rather than the more obvious

this.[b]

with brokets "<" and ">" in place of the [], "duh".

OBloodyHell said...

Back OT -- bobn, the key element here is this, and you bypass it entirely:

For some reason, the Federal Reserve convinced itself that it could focus exclusively on the prices of consumer goods instead of taking asset prices into account when setting monetary policy. In July 2004, the federal funds rate was just 1.25 percent, at a time when urban property prices were rising at an annual rate of 17 percent. Negative real interest rates at this time were arguably the single most important cause of the property bubble.-

The action of the fed, by making money excessively cheap to borrow, is a guaranteed problem.

When I can borrow at 1.5% and put it into an investment growing at 17%, you would be a f***ing MORON not to do so.

So it was the actions of the FR, in keeping rates arbitrarily low (that would be a flaw in REGULATION), that caused this.

And yes, it was a large part of the cause of the dot-com bubble, too. It's got nothing to do with partisanism in any way, shape, or form. When you keep interest rates excessively low, i.e., "cheap money", but there is a boom market to be invested in, you encourage speculation, and that makes the problem ridiculously worse. Period.

Or were you thinking of claiming that Bush&co were retroactively responsible for Tulip Mania?

bobn said...

OBH:

First, thanks for the heads up on the HTML workaround. I was wondering why it seemed so inconsistent - I suppose my use of markup must have been inconsistent.

Second: Or were you thinking of claiming that Bush&co were retroactively responsible for Tulip Mania?.

Can we say "Straw Man"? Thought so!

Third: Alan Greenspan absolutely has a lot to answer for. It is not unreasonable to point at the FRB policy of keeping money so cheap so long as a huge meddling in the economy. It started something going in 2002 through 2004 - no doubt. But the FRB also contributed by refusing to regulate - Greenspan has since declared himself shocked that the management of the banks did not act to protect shareholder value. He thought the market would do that, unregulated - he thought wrong.

But, by mid-2005, rates were back up to much more reasonable levels - yet the terrible underwriting continued and worsened significantly by all accounts. Several examples: one report by a former Treasury official, The Financial Crisis: An Inside View notes:

"What we missed was that the regressions did not use information on the quality of the
underwriting of subprime mortgages in 2005, 2006, and 2007. This was something
pointed out by staff from the Federal Deposit Insurance Corporation (FDIC), who had
already (correctly) pointed out that the situation in housing was bad and getting worse"
.

and includes this graph showing how poorly the later vintages fared. And on the commercial real estate side, S&P said 2 days ago (5/26), per this CR post, that they expect:

"a considerable amount of downgrades in recently issued (2005-2008 vintage) CMBS. Classes up through the most senior tranches of outstanding deals (so-called "A4s," "dupers," or "super-duper seniors") are likely to be affected. Our preliminary findings indicate that approximately 25%, 60%, and 90% of the most senior tranches (by count) within the 2005, 2006, and 2007 vintages, respectively, may be downgraded. We believe these transactions are characterized by increasingly more aggressive underwriting than prior vintages.".

So here, in the commercial MBS, as in residential, we see incredibly bad actions increasing after 2004, or thereabouts.

So what happened? In 2004, the I-Banks were allowed to "self-regulate" and to increase their leverage from about 12:1 to about 30 or 40 to 1. I simply remain convinced that these events are related - that all this newly "available" money looking for yield, combined with Yield Spread Premium paid to originators (paid more for the toxic loans) caused what happened *after* the FRB tightened their rates.

OBloodyHell said...

> Can we say "Straw Man"? Thought so!

HEY, there's bob's total lack of logic for you!!

You can SAY "straw man" all you want. You can SAY "I want sex with Giselle Bundchen", too. Neither has any affect on reality.

In other words -- i.e., "logical ones" -- if you're going to SAY "straw man", you have to follow it up with an actual ARGUMENT which makes your case.

> But, by mid-2005, rates were back up to much more reasonable levels

Cite "reasonable levels", bob. Were the loan rates in the double digits? (one word: "Duh?") If they weren't, how do you figure it's going to stop? Unless the rates are such that it's not profitable to take out a loan and buy property which is rising faster than the rate on the loan, then the rates were not high enough. Stress on that: DUH!!!.

Clearly, you have no grasp of he overarching effects of "cheap money" on any aspect of the economy.

So, yeah, I can say "straw man". bob!! And what you did is, indeed, a tour-de-force. Thanks. I understood the principle completely, but in case anyone else was fuzzy on it, you showed a great example of one.

Further, once more, you make the imbecilic argument of expecting instantaneous shifts in direction in a massive, ponderous economy:

> yet the terrible underwriting continued and worsened significantly by all accounts.

This certainly isn't going to just "stop" on a dime, unless there is literally no money out there that's cheap. Since, at whatever percentage it was at was waaaay below the constant rise in home prices (because, "you know, property values never go down". Uh, thanks, but I lived in Orlando, FL, in the early 1970s. YES THEY DO.), the process of making bad loans to stupid people isn't going to stop.

It's the CRA, bob. At this point, as you love to harp on, the snowball is LOTS bigger than the little rock that started the thing rolling, but, if it weren't for that rock, the giant snowball wouldn't have existed in the first place.

> and includes this graph showing how poorly the later vintages fared.

And improperly supplies a suggestion of cause and effect...

As things went steadily south starting in 2005, it's hardly surprising that they got worse as the economic situation got worse.

Should the loan requirements have been tightened up (oh, to say, the kind of standards that applied before the CRA distorted the market, perhaps??)... Well, DUH. They should never have been relaxed like that in the first place.

Sorry, bob. The seedcorn for this isn't Jack's friggin' beanstalk. It did not sprout overnight. It took many, many years before the explosive growth phase you love to point at as the be-all end-all whole of the problem.

> So what happened? In 2004, the I-Banks were allowed to "self-regulate" and to increase their leverage from about 12:1 to about 30 or 40 to 1

And why should they not? In 2004, Franklin Raines is arguing IN FRONT OF CONGRESS that 1 or 2 percent is completely adequate. And the Dems are falling all over themselves agreeing with him, bob, and instead giving SHIT to the OFHEO bureaucrat (you know, the Bush admin people you keep lying about not doing anything?) trying to actually head off this mess at the pass.

> what happened *after* the FRB tightened their rates.

Again, bob -- to what? Was it 10%? 13%? 15%? Because it's got to be a LOT higher than any interest rate I've heard of to be able to dissuade people from taking out such loans and turning them around and buying property with them which they expect to continue rising at 12, 14, or 17%.

If you can rely on a 2% difference being sustained, that adds up to a LOT of free money, bob.

...(continued)...

OBloodyHell said...

...(continued)...And that's what you don't seem to get at all:

1) This isn't a short-term thing.

2) It did not happen overnight.

3) While certainly some Bush policies contributed to it, and proper, overt action might have been able to stop it (unlikely, though, given the political exigencies and the mass of forces in resistance from The Left, most particularly Barney Frank), it was hardly -- not even largely -- Bush admin policies which caused it, despite your almost maniacal determination to promote this absurdist meme.

Carl said...

bobn:

Your narrative about Canadian banking regulation seem overly, perhaps fatally, simplistic (particularly noteworthy is the fact that most Canadian mortgages are fully recourse, with very different consequences for family finances after default). Also, it may be too early in the business cycle to be certain.