Sunday, September 21, 2008

People make mistakes...

... but for really fucking colossal mistakes, well, you can nearly always look to the state for those. Let us take the Credit Crunch...

Now, this was partially caused by greedy bankers, it is true; but it wasn't entirely their fault. Y'see, what is at the heart of the Credit Crunch is a loss of faith in the value of mortgage loans. One of the reasons—or, rather, the main reason—for this loss of faith was that the bankers had been doling out mortgages to people who would probably not be able to make the payments. These people were not optimal borrowers because they had a high risk of default: in fact, they were not prime borrowers, but sub-prime.

As a result, because the risk of sub-prime borrowers defaulting, their mortgages cost more than those of prime borrowers. These higher-cost mortgages were known as "sub-prime mortgages", for obvious reasons.

(I realise the irony of this system: after all, if their mortgages were not more expensive than prime mortgages, then the chances of these people defaulting would be a little less. However, that is not how risk works.)

Now, a large number of defaulters in the US led to a couple of small banks going bust. This then started something of a panic which escalated into the shit-storm that we see today.

Now, the real question that needs to be asked is "why were so many sub-prime mortgages dealt out?" The risk assessors in banks are generally pretty smart guys, and they have teams of researchers and reams of reports to help them to control their banks' exposure to such problems.

Via Alex Singleton, I have rediscovered a Forbes article, which I saw some time ago, which may go some way to answering the above question and may also provide a counter to those who are lining up to blame the eeeeeevil "free market". [It's worth reading the whole article, but here is the meat of it, with emphasis by me—DK]
All this overlooks a crucial fact: There has been no free market in housing or finance. Government has long exercised massive control over the housing and financial markets—including its creation of Fannie Mae and Freddie Mac (which have now amassed $5 trillion in liabilities)—leading to many of the problems being blamed on the free market today.

Consider the low lending standards that were a significant component of the mortgage crisis. Lenders made millions of loans to borrowers who, under normal market conditions, weren't able to pay them off. These decisions have cost lenders, especially leading financial institutions, tens of billions of dollars.

It is popular to take low lending standards as proof that the free market has failed, that the system that is supposed to reward productive behavior and punish unproductive behavior has failed to do so. Yet this claim ignores that for years irrational lending standards have been forced on lenders by the federal Community Reinvestment Act (CRA) and rewarded (at taxpayers' expense) by multiple government bodies.

The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound. Under the CRA, banks must convince a set of bureaucracies that they are not engaging in discrimination, a charge that the act encourages any CRA-recognized community group to bring forward. Otherwise, any merger or expansion the banks attempt will likely be denied. But what counts as discrimination?

According to one enforcement agency, "discrimination exists when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants." Note that these "arbitrary or outdated criteria" include most of the essentials of responsible lending: income level, income verification, credit history and savings history—the very factors lenders are now being criticized for ignoring.

The government has promoted bad loans not just through the stick of the CRA but through the carrot of Fannie Mae and Freddie Mac, which purchase, securitize and guarantee loans made by lenders and whose debt is itself implicitly guaranteed by the federal government. This setup created an easy, artificial profit opportunity for lenders to wrap up bundles of subprime loans and sell them to a government-backed buyer whose primary mandate was to "promote homeownership," not to apply sound lending standards.

Of course, lenders not only sold billions of dollars in suspect loans to Fannie Mae and Freddie Mac, contributing to their present debacle, they also retained some subprime loans themselves and sold others to Wall Street—leading to the huge banking losses we have been witnessing for months. Is this, then, a free market failure? Again, no.

In a free market, lending large amounts of money to low-income, low-credit borrowers with no down payment would quickly prove disastrous. But the Federal Reserve Board's inflationary policy of artificially low interest rates made investing in subprime loans extraordinarily profitable. Subprime borrowers who would normally not be able to pay off their expensive houses could do so, thanks to payments that plummeted along with Fed rates. And the inflationary housing boom meant homeowners rarely defaulted; so long as housing prices went up, even the worst-credit borrowers could always sell or refinance.

Thus, Fed policy turned dubious investments into fabulous successes. Bankers who made the deals lured investors and were showered with bonuses. Concerns about the possibility of mass defaults and foreclosures were assuaged by an administration whose president declared: "We want everybody in America to own their own home."

Further promoting a sense of security, every major financial institution in America—both commercial banks and investment banks—was implicitly protected by the quasi-official policy of "too big to fail." The "too big to fail" doctrine holds that, when they risk insolvency, large financial institutions (like Countrywide or Bear Stearns) must be bailed out through a network of government bodies including the Federal Deposit Insurance Corporation, the Federal Home Loan Banks and the Federal Reserve.

All of these government factors contributed to creating a situation in which millions of people were buying homes they could not afford, in which the participants experienced the illusion of prosperity, in which billions upon billions of dollars were going into bad investments. Eventually the bubble burst; the rest is history.

Given that our government was behind the wheel, influencing every aspect of the mortgage crisis, it is absurd to call today's situation the result of insufficient regulation.

Having read a similar article a long time ago, your humble Devil put forward this idea at a lunchtime meeting of a certain think-tank, and was derided. It seems to me, however, a perfectly logical argument.

As usual, the state made a bunch of laws in order to fulfill a political objective and failed to consider the unintended consequences of said laws. These unintended consequences more often than not come about because politicians—despite being some of the most selfish and corrupt people on the planet—usually fail, wilfully, to recognise that humans are intrinsically self-interested. It is particularly stupid as this is something that Adam Smith recognised many years ago.
It is not from the benevolence of the butcher the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages.

One of the things that is really pissing me off at the moment is the glee and self-righteous venom with which comedians, in particular, are seizing upon the misfortunes of bankers; not only are they spouting, in the main, tediously obvious material but comedians are, let's face it, one of the most self-regarding and self-loving strains of human being on this fucking planet. But the comedians' rantings are only the most obvious and pointed manifestation of the equally distasteful tendency towards self-righteousness in everyone else.

Yeah, right: because you guys definitely would not have seized upon the chance to stuff your pockets with money were you in the same situation, eh? You would have protested, wouldn't you? You would have held your hands up and said, "no! I don't want this massive, million pound bonus."

Unless you can look into yourself and absolutely, honestly tell yourself that you wouldn't have done precisely the same thing as these bankers were you in the same position (and I reckon that there are pretty fucking few of us) then I really suggest that you shut the fuck up.

Now, as for the fucking politicians...


Mark Wadsworth said...

House price/credit bubble in USA can be partly blamed on CRA, there is no doubt about that.

But it is more a cyclical thing - there are slightly different factors in play in USA, UK, Ireland, Spain, Australia, NZ, CHina, but it boils down to the same fundamental thing.

Namely, in times of low inflation, low interest rates and easy credit, all the extra money goes into property, but as there is a fixed supply of property, all that happens is that prices shoot up.

The cost/value of bricks and mortar can't go up, they are worth what they are worth. So it is the price of land that goes up - house prices may have trebled over the last ten years, but actually it is land prices that have gone up ten fold. Producing super tax free profits for property owners

Ergo, how about having a tax on land values to prevent bubbles arising?

If I could be bothered, I'd link to quotes from Adam Smith and Ricardo and Milton Friedman saying this.

There are so many other taxes we should be getting rid of. LVT is one of the few taxes that actually has some positive effects.

AndNowInStereo said...

I see you've been watching Mock the Week, then?

marksany said...

There are plenty of people who leave jobs where they do not like the greed and dishonesty in an industry and move to a more ethical job, or take a more ethical job in the first. Good job, too, or there'd be no nurses or teachers.

Anonymous said...

Excellent work DK, especially the final two paragraphs. These sanctimonious pricks piss me off more than anyone else.

Anonymous said...

The risk assessors in banks are generally pretty smart guys

Oh really? If I approached "risk" in the same casual manner, I would be in jail.

Simple as.

Anonymous said...

lost_nurse said... "If I approached "risk" in the same casual manner, I would be in jail."

Better not be quite so self-righteous, eh? The NHS is not renowned for being risk free - think "postcode lottery", MRSA etc.

McBroon's complicated, confusing tripartite oversight of the finance industry totally failed to prevent the problems occurring in the UK; then failed to spot them when they had. The banks assumed that if the regulators okayed what they were doing it must be all right. This is how state over-regulation infantalises everyone.

There are more and more regulations every year. Sooner or later these fail or have unintended consequences (politicians are not omnipotent). Then there is the clamour for yet more regulation. This is insane - if we never change what we do we will always make the same mistakes. We need fewer regulations not more.

Anonymous said...

lost_nurse, did you even read the post? These people have been forced to lend to high-risk borrowers. They also know that government will pick up the pieces when bad risks fall. So no matter how smart they are, they're bound to take worse risks than they would otherwise.

Anonymous said...

It's all correct, except that the Federal Reserve is not a government institution, its run by private banks.

Timothy Wallace said...

Mark Wadsworth: erm, yes the price of bricks and morter can go up, in the same way as any good in high demand. Similarly, the cost of getting builders to put the houses up also changes based on demand for houses - so it isn't just the price of land which changes.

Also, even if it was just the price of land which changed, why shouldn't owners and investors be able to take advantage of changes in price? If lots of people want to live there, the price should change accordingly, and that's no reason for the government to take a slice on the vague basis of being good for people - not least because slapping a tax on something immediately raises its price.

Devil's Kitchen said...


What Tim said. Seriously...

"The cost/value of bricks and mortar can't go up, they are worth what they are worth."

Let us rephrase that, shall we?

"The cost/value of land can't go up, it is worth what it is worth."

Barking, my friend: absolutely barking.

The only way in which your assertion could even pretend to have any value at all is if every single house in Britain were precisely the same.

We might then say that it must be the land value which has gone up. Since every house in Britain is not the same, your assertion is erring upon the ludicrous.


Larry Teabag said...

Yeah, right: because you guys definitely would not have seized upon the chance to stuff your pockets with money were you in the same situation, eh?

You're begging the question. If they were in the same situation, then they would already be greedy bankers, and so a forteriori money-grubbing wankers who'll fill their pockets regardless of the consequences for anyone else.

I don't know why you think it's "self-righteous" to make this sort of obvious and truthful observation about businessmen, but insightful to the point of being heroic when you say exactly the same thing about politicians.

comedians are, let's face it, one of the most self-regarding and self-loving strains of human being on this fucking planet

Second only to bloggers, I'd say.

Anonymous said...

lost_nurse, did you even read the post?

FFS, yes. And whose fault - exactly - is the fancy re-packaging & selling-on of debt? The endless justification for bonus culture? Don't make me laugh... DK, you can't defend market discipline on the one hand - and then come out with this weak defence for boot filling.

Anonymous said...

So Lost_nurse, what do you call premium bonds, National Savings accounts, PFI, unfunded public sector pensions? Packaged debt? I am afraid greed and incompetence are human traits which no amount of regulation will eliminate.

The government has no wealth to earn the money required to service these massive debts. If it was a business that had to sell what people wanted, it would be bust and its shares worthless.

For 10 years McBroon has supervised the banks. But obviously not very well. It was capitalists like Soros and Buffet who warned of the impending bubble bursting.

Anonymous said...

You don't have to be Soros or Buffet to recognise a fcuk off big pyramid scheme.

Don't get me started on PFI...

Anonymous said...

I have to disagree on grounds of logic. The rightness or wrongness of a particular course of action should not be determined by whether I would do the same in the same position.

Me being just as selfish as the bankers doesn't make their (and my) actions any the less selfish.

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