Tuesday, June 23, 2009

Finance V

Blogger bobn insists that increases in allowable investment bank leverage was the principal cause of the mortgage crisis, as opposed to regulation of the GSEs (Fannie Mae and Freddie Mac):
[T]he 2004 tripling of leverage allowances at the 5 big I-Banks certainly did. My mortgage disaster post, which Carl seems to have read very poorly, shows how these events were related temporally (1st part of my post) and causally (2nd part of my post). . .

Congress made no law requiring OFHEO to keep it's hands off of FNM and FRE. Short of a law, all the ranting in the world makes no difference to the fact that a regulator is supposed to regulate.
As part of a continuing series, my reaction:
  1. bobn's post quotes a liberal housing pressure group-affiliated website saying "Because investment banks provide subprime lenders with necessary funding, they wield a great deal of power in determining what sorts of loans are offered to subprime borrowers." Well, sort of--investment banks provided funding. But they didn't hold a gun to borrowers' heads. As I have said, much of this crisis was demand driven (though for some reason that notion outrages bobn). Which is why today even prime mortgages are increasingly under water.


  2. Even assuming investment bank funding was the driver--the link claims only "a great deal of power"--of subprime lending, why do I care about investment bank regulation? Investment banks are not government insured--investors assume the risk. The fact that their decisions didn't pan out should be irrelevant (so long as the government doesn't bail out investment banks as the Fed did for Bear Stearns). So, I still can't get too excited about liberalizing investment bank leverage limits--the regulatory issue still centers around the oversight of commercial banks, including commercial bank affiliation with non-bank mortgage lenders.


  3. bobn's claim that Congress didn't pass laws encouraging Fannie and Freddie to up mortgage lending to less credit-worthy borrowers (via subprime, Alt-A, etc.) is naive and misleading. He overlooks a decade of "regulation by raised eyebrow" where Congress pressured the GSEs to boost and broaden mortgage lending. And he omits the fact that HUD was the Hill's handmaiden:
    For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.
  4. Along with economist Arnold Kling, bobn and I agree that repealing Glass-Steagall wasn't the problem but that the treatment of credit default swaps and off-balance sheet assets bear some of the blame. Yet that doesn't bolster the case for the sort of over-regulation President Obama proposes,1 as Stephen Spruiell says in the July 6th National Review on dead tree (subscription-only for now):
    The argument that a lack of regulation caused the crisis is seductive in its simplicity; it completely ignores the other side of the government equation. Regulation is seldom necessary unless the discipline of a truly free market is absent -- such as when the government indemnifies companies or industries against failure, or when it juices markets with generous subsidies. In the case of the housing bubble, both of these distortions were present. Wall Street titans, led by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, juiced like Jose Canseco until they grew "too big to fail." In retrospect, it looks like a failure to regulate; in fact, regulations wouldn’t have been necessary if the government hadn’t provided the steroids. . .

    It is true that without Gramm-Leach-Bliley, Citigroup could not have grown as large as it did. But there is no evidence that Citi’s size or diversity of business lines had anything to do with its overinvestment in mortgage-backed assets. Financial institutions that did not diversify made the same mistake, and they arguably fared worse during the crisis. Bear Stearns, the first investment bank to collapse under the weight of its bad assets, did not have a commercial-banking arm. Furthermore, without Gramm-Leach-Bliley, commercial bank J. P. Morgan could not have mitigated the consequences of Bear’s collapse by acquiring it. (On the other hand, the Federal Reserve’s facilitation of the sale of Bear created the hazardous expectation that every failed firm would get a bailout.)

    As for the CFMA, Kevin D. Williamson and I have written in these pages that institutions buying credit-default insurance should be required to have a real insurable interest at stake. As it stands, an institution can buy insurance on a bond it doesn’t even own. That said, losses on credit-default swaps have been smaller than expected, because so many transactions are "netted" -- institutions buy credit protection and then sell it at a higher price, so their exposure is hedged. When Lehman Brothers declared bankruptcy, institutions that sold credit protection on Lehman bonds were projected to lose as much as $400 billion. After all the transactions cleared, though, sellers had lost only $6 billion on their Lehman trades. AIG’s portfolio of credit-default swaps presented a bigger problem, as the mortgage-backed assets they insured started to sour.

    But, contra Scheer [and bobn], deregulation was not the primary or even secondary reason that mortgage lending spun out of control. Government promotion of homeownership set the table for a massive run-up in real-estate borrowing, and the Federal Reserve’s loose monetary policy in the early 2000s rang the dinner bell. . .

    To be sure, the investment banks were more than happy to buy up the rest of the toxic debt, but one reason these banks took on too much leverage was their confidence that, in the event of a downturn, the Fed would cut interest rates -- and keep them low -- to stimulate the economy. They called this "the Greenspan put" after former Fed chairman Alan Greenspan (a "put" is a financial option purchased as protection against asset-price declines). The Fed had cut interest rates to stimulate growth after the tech bubble burst, and it had cut them to historically low levels after the 9/11 attacks. From late 2001 to late 2004, the Fed held interest rates under 2 percent, making investors desperate for a decent rate of return. Mortgage-backed securities met that need. Harvard professor Niall Ferguson recently contended in the New York Times Magazine that "negative real interest rates at this time were arguably the single most important cause of the property bubble." . . .

    The Left continues to propagate the myth that a zeal for deregulation did us in, because it prefers government interference in the marketplace. That’s why it’s important to remember that, for the current economic disaster, government interference bears much of the blame.
Conclusion: Increased transparency--including tax policy--makes sense. But if Federal interjection was the flaw, increasing avenues for Federal regulators to intervene isn't necessarily the fix.

________________
1 I'm particularly troubled by the President's plan to "reverse-preempt" and give states "the ability to adopt and enforce stricter laws for institutions of all types, regardless of charter, and to enforce federal law concurrently with respect to institutions of all types, also regardless of charter" (White Paper at 60). The result would give state-charted banks an enormous comparative advantage over nationally charted banks--the former would fall under the oversight of a single regulator, rather than 51 potentially inconsistent regulators. This would steamroll national banks to abandon their current charter for a state charter, effectively ending national banking.

22 comments:

OBloodyHell said...

> He overlooks a decade of "regulation by raised eyebrow" where Congress pressured the GSEs to boost and broaden mortgage lending.

More importantly, bobn has relentlessly ignored the obvious facts -- when OFHEO attempted to call attention to the -- by government standards!! -- shoddy accounting by the GSEs, the leading Dems on the Senate Banking Committee, rather than looking askance at the GSEs, turned around and praised them, and then excoriated the OFHEO representative for daring -- daring! I say!! -- to cast doubt on the financial state of the GSEs.

All this is not just conjecture, but is readily visible from CSPAN footage of said meetings.

Within a little over a year, the GSEs were getting rescued by the Fed.

Yes, indeed.

Despite this, bobn has claimed, on repeated occasions, that this failure of oversight was the fault of the Bush admin (i.e., the guys who direct OFHEO) rather than the Dems on the SBC.

Sorry, charlie//// sorry, "bobn" -- when a powerful Senator tells a mid-level bureaucrat to "take a hike, stop bothering my pet project", said mid-level bureaucrat just gets out of the way and shuts his mouth, if he plans to have any kind of career.

OBloodyHell said...

P.S. they finally fixed that damned line-joining bug:

test 1

line 2

line 3

OBloodyHell said...

> This would steamroll national banks to abandon their current charter for a state charter, effectively ending national banking.

Quite unintentional, I'm sure...

MMM-hmmm. Yeah.

bobn said...

Since Carl kindly links to my best arguments, I'm almost tempted to not respond at all. However:

1) FNM and FRE were only 15% of the problem. Get over it.

2) I care about investment bank actions and am "outraged" that people could, during the I-Bank driven bubble get mortgages at 9x their income, or with payments of 95% of take-home, (as in the Andrews case), because these actions have led to an economic crisis. You and OBH still seem to think this is/will be a typical recession. Wrong.

3) I've said everything I'm going to say about GSE regulation here.

4) For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

And yet only 15% of the bad mortgages are GSE and 51% are Wall-Street backed. Go figure.

5) But they didn't hold a gun to borrowers' heads. As I have said, much of this crisis was demand driven (though for some reason that notion outrages bobn).

Once upon a time, before Wall Street got involved (see the graphs for timing), there was a word that originators had for people who wanted to borrow 9x their income, or have mortgages payments equal to 95% of their monthly take home. That word was "NO". People can have all the "demand" they want - if the lenders had said "no" it would not have mattered.

6) Well, sort of--investment banks provided funding.

And paid originators more for more toxic loans. See here:

The big money for unscrupulous brokers, however, lies in steering borrowers into higher cost loans. A prime, fixed-rate loan at par may earn a broker a fee of one percent or less, but a hybrid adjustable rate mortgage (ARM) can pay four percent or more.

The Center for Responsible Lending (CRL) has said that inflated YSPs are included in 85 to 90 percent of all subprime mortgage loans.

Borrowers of hybrid ARMs, nicknamed "exploding" or "toxic" ARMs, often get stuck with prepayment penalties that penalize a borrower for paying off a loan early -- which can run into the equivalent of six months of mortgage payments. They guarantee lenders will get back their initial outlay over time and lock consumers into high-priced loans
.

bobn said...

effectively ending national banking.

Good idea! The answer to "too big to fail".

bobn said...

Carl disngenuously says: Which is why today even prime mortgages are increasingly under water.

Even though I've already pointed out that both T2 and common sense show that this is an effect of the Wall-Street driven bubble, not a cause, Carl repeats this worn out and disproven argument.

suek said...

More to read on the topic - even if bobn thinks he's not a steady source... I figure that where there's smoke, there's fire.

http://market-ticker.denninger.net/archives/1149-Congress-Has-No-More-Excuses.html

suek said...

>>And yet only 15% of the bad mortgages are GSE and 51% are Wall-Street backed. Go figure.>>

Yes...puzzling indeed. You don't suppose that it could have anything to do with the fact that due to the CRA, the banks were required to take loans they'd have preferred not to? Or maybe it's due to the fact that private enterprise has a profit motive and GSEs don't?

bobn said...

Suek,

see here for CRA.

Also, I read Denninger a lot. Most of what he says makes sense.

OBloodyHell said...

Suek, it goes another way, too, which bobn continues to ignore, never refuting, just attempting to pretend it's not so:

The GSEs cheated. They claimed they were making spectacular returns on dodgy investments. The purpose of this was to get Gorelick and Raines their big fat bonuses, which, if the reality had been acked, they would not have gotten, period.

Private industry isn't all geniuses. Some of them are quite incompetent. When they see someone apparently hauling off gold, they want to get in on the deal. A smart person would have wondered how all that gold came from that that place, but, hey, that's what swindles are all about, aren't they? The greed and gullibility of the marks.

So, once the groundwork was set by the cheating and lying of the GSEs, the idiot brigade started jumping on the bandwagon. Given that, as you note, they were being nudged in that direction by the JD and the PR threats from groups like ACORN, they didn't need a hard push in that direction, either.

And THAT has a lot more to do with this mess than anything else bob has to say.

Bob looks at the giant snowball that just ran us all over, and says, see, look, the GSEs were just a tiny little rock in that snowball...

He cannot seem to grasp the notion that it was the rock, which started rolling down the hill up at the top which created that giant snowball. Without the rock, there is no snowball.

He never, ever refutes this, he just ignores it, or naysays it, or points to some other thing which is peripheral to the point.

Which is why I've stopped arguing this with him, he's unable to take a good look at how things build.

He wants only to look at the end result and assign all the blame to the people caught in the chairs when the music stopped. Who are conveniently Republicans.

Bob tries to claim he's middle of the road, but he's still a lefty Dem by most lights.

Case in point:

Not once, but THREE TIMES
1
2
3

Three times, he sees fit to give Bush crap for being "overly friendly" with the leader of Saudi Arabia on one single occasion.

Obama, on the other hand, bows before the Saudi King, as though he were a subject.

Does bobn see fit to SAY A SINGLE WORD?

He does not.

'Nuff said. Actions speak louder than words.

bobn's speak volumes.

suek said...

More questions...

what about this?

bobn said...

Carl's view of GSE regulation is silly and self-contradictory:

[bobn] overlooks a decade of "regulation by raised eyebrow" where Congress pressured the GSEs to boost and broaden mortgage lending. And he omits the fact that HUD was the Hill's handmaiden:

For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.


So he concedes that HUD (executive branch) did have the ability to regulate the GSEs - the point I have made all along.

And he claims HUD was controlled by "the Hill" into decreasing lending standards by Congress in 1996, 2000 and 2005 - years in which Congress was controlled by - wait for it - Republicans.

OBH: I've long since stopped reading your posts in any detail. You are immune to facts and logic.

bobn said...

Suek,

I haven't a clue about the specific story you link to.

One new swindle I've heard of is the same folks that used to be realtwhores form businesses to "help" unload REO, only to steer it to their buddies at below market prices. Said buddies then flip the property. Maybe something like this is going on.

I never said the GSEs were great, I just said they weren't anything like the main problem, and in any case, were one of BushCo's many screwups.

bobn said...

Suek,

The Denninger piece is good. Unfortunately, the prosecutions will never happen. The Big money owns D.C. - the one thing I agree about with that idiot Dick Durbin.

Carl said...

bobn:

I never said the Executive Branch wasn't complicit as well; rather, I was refuting your claim that it "wasn't the GSEs." Seem to me that you're now agreeing with me.

OBloodyHell said...

> So he concedes that HUD (executive branch) did have the ability to regulate the GSEs - the point I have made all along.

The point is on your head, bob.

You have repeatedly ignored the fact that THEY CAN'T REGULATE WHAT SENATORS WON'T ALLOW THEM TO.

That they can "technically" do so is IRRELEVANT when the reality of the situation makes it impossible.

I can give you the "power" to regulate the temperature in my home, bob, but if you don't know where I live, and don't have a key, you can't do it.

Responsibility without authority is meaningless.

The Bush admin mid-level bureaucrats whose responsibility this was only had the power to refer it to the legislature for attention.

> OBH: I've long since stopped reading your posts. You are immune to facts and logic.

No, bob, you are the one immune.

YOU NEVER LISTEN, NEVER DISPUTE points you don't like. You just IGNORE them.

Refute it, bob:

Fact 1:
The SENATE directly interfered with the proper oversight of which you complain the admin did not perform.

The Senate is not just ON RECORD as having done so, they are READILY VISIBLE on CSPAN footage DOING SO.

Yet you continue to blather on about how the admin didn't do its job.

Its job was to call attention to the irregularities for the legislature to act on. It did so. The legislature DID NOT do ANYTHING, and sent a clear message to all bureaucrats that the GSEs were to be left alone to do as they would...

Fact 2:

The GSEs were the heart of the giant snowball which ran over the economy. That they were but a small part of the problem by 2005-2006 is irrelevant. Without them misleading financiers by producing fraudulent earnings reports, a lot more financial people would have been far more circumspect about a large percentage of these activities which were defacto risky.

Franklin Raines is ON CSPAN VIDEO claiming that the mortgages in question are so "risk free" that 1% is more than adequate capital reserve (that would be something you've indicated is also at the heart of this problem, remember, bob?)

I have put BOTH of these before you time and again, and each time you ignore, obfuscate, bypass, tapdance, and jump through pretty much every possible logical and rhetorical contortion to avoid dealing with them -- "But look over here!" -- "No, it's this" -- "This link describes the 'real' problem..." etc., etc., etc., ad nauseum.

The only one "immune" to facts and logic around here is you, bob.

> Seem to me that you're now agreeing with me.

No, Carl. That's bobn's little tap dance around things. Just watch. Nothing in his stance will change:

1) It was ALL the Bush Admin's fault

ergo

2) The GSEs were insignificant

ergo

3) The Dems in the Senate? Completely innocent. Ditto the Dems running the GSEs.

Bob only has it in for conservatives/republicans in this.

The Dems part in it, much like Obama's renunciation of American Soverign authority, never happened.

The fact is, this whole mess was 65% Dems, 25% GOP, 10% Greedy Businessmen, and 5% Greedy RE investors.

OBloodyHell said...

> And he claims HUD was controlled by "the Hill" into decreasing lending standards by Congress in 1996, 2000 and 2005 - years in which Congress was controlled by - wait for it - Republicans.

Another defacto lie on bob's part.

The whole of Congress does not mean all control resides in the party in power. The committees in question have vast authority (see previously mentioned SBC CSPAN footage), and Dems had control over plenty of those.

Proof of this lies in the obvious fact that the GOP judicial nominees were held up in committee for most of the last 5 years.

It was technically possible to override that, but not a trivial action to do, and the GOP demonstrated a lack of spine when it came to doing anything if the Dems threatened to hold their breath until they turned blue if they didn't get what they wanted.

Despite having a majority in Congress, the Dems still held control over a large number of key committees, and they used that power ruthlessly to obstruct anything they did not approve of.

bobn said...

Carl said:

Seem to me that you're now agreeing with me.

As noted, GSEs have 15% of the currently bad mortgages.

Wall Street has 51%, soon to be more. And Wall Street's dollar number will increase too, as they have all the Option ARM madness from California, which in almost every case will become a large default.

And OBH's "the GSEs made/inspired them do it" fails the laugh test.

It would be almost like somebody saying that because W doubled the national debt, it is OK for Obama to quadruple it - and that Obama's quadrupling would *still* be W's fault! I do not agree with this argument, but it's the only thing silly enough to compare to OBH's argument. In fact, this silliness is still stronger than OBH's argument, because W left Obama with an absolutely hideous mess. The GSEs did nothing to Wall Street.

OBloodyHell said...

> Despite having a majority in Congress, the Dems still held control over a large number of key committees, and they used that power ruthlessly to obstruct anything they did not approve of.

Further proof of this comes in the Social Security fiasco. Despite efforts to reform it, they could not get any headway on it because before their majority could hold sway they had to get it out of committee, where the Dems kept it bottled up. Since the people weren't pushing for it, they didn't see it as politically astute (something that I believe contributed to their defeat in 2006 -- one of the chief complaints of conservatives was the lack of action on key items such as this)

OBloodyHell said...

> see it as politically astute
... to force the issue (DOH!)

OBloodyHell said...

> And OBH's "the GSEs made/inspired them do it" fails the laugh test

Ah! You went with the technical refutation!!

Excellent idea, my reasoning hath been undone!!

/snark off

OBloodyHell said...

> The GSEs did nothing to Wall Street.

Except mislead them as to whether there was money to be made. Certainly nothing relevant to Wall Street.