The financial sector is absurd. They pretend to be contributing to society for their inordinate compensation when really they’re just playing games with everyone’s future’s. Just make it simple and government run. Get our smartest people back to developing things that actually help humanity instead of just trying to figure out how best to cheat it.
The bursting of the housing bubble caused the recession, not the other way around. In CA, AZ, NV and other areas, workers shifted toward construction and real estate because it was so easy for people to borrow money to buy a house. When prices collapsed many of those construction and real estate people were thrown out of work and it’s going to take a while for them to find something else to do.
Many people got into trouble with their mortgages because they took them out on the premise that they’d never really have to carry them on a permanent basis - they would soon sell into a market that was supposed to be permanently booming. When they lost that option and their teaser rates adjusted, they couldn’t make the payments whether they had a job or not.
Trying to perpetuate a housing bubble by subsidizing mortgages is the wrong policy. It can’t go on forever. The more people dependent on the subsidies, the worse it’s going to be when the market returns to an equilibrium level.
Is a theory. In practice, it worked fine in most of Europe.
Which is why the Euro isn’t on the verge of collapse.
I think this is a great point. A bailout is a loan, not necessarily free money. So giving a bailout to homeowners is basically akin to strapping debt-ridden homeowners with more debt. Either that or you pay off the banks anyway. It seems like no matter how you slice it, you have to give the money to the banks. It makes me wonder why Paul says “we should bail out the homeowners” instead, unless he means literally giving money to homeowners. But I see a lot of moral hazard with that.
However, one thing I don’t understand is how TARP turns a profit. Isn’t this just the Broken Window Fallacy?
TARP was the best we could make of a bad situation. Its easy to look back and say that there was some better more optimal strategy (which if perfectly executed, would yielded better results). TARP ultimately did not cost the taxpayers much (it was better than the AIG bailout or the Fannie Freddie bailouts, which IMHO should have been structured more like the GM bailout) although there is evidence that we overpaid for many of the assets we purchased (particularly stock) but most of those assets were largely repurchased by the troubled companies plus dividends and interest.
I guess we could have crammed down on fannie and freddie and made their shareholders and bondholders endure the losses to let underwater homeowners write down mortgages. Its a bit totalitarian but we were in extraordinary times. But how would you have done it all in time to prevent the global colapse of a GLOBAL economy that some thought was days away from Mad Max world. You think the world would have sat patiently by, waiting for America to work out its mortgage crisis while the global financial system was frozen or very sluggish. While grain shipments were rotting in the holds of ships?
And frankly sine the crisis, we have tried the sort of programs that people are suggesting and they just have not been heavily subscribed.
I think you might be mistaking the easy credit fo the mid 2000’s for the norm. The easy credit of the mid 2000’s are gone so now everyone has to meet Fannie/Freddie/FHA guildelines. 20% down with good credit, and good income expense ratios or one of the FHA 5% down programs. Fannieis still making a market in mortgages as long as you qualify, its just that with the economy the way it is, people don’t find it as easy to qualify.
Bailing out the homeowners would have been straight up loss to government and s traight up money directly to the bottom line of the banks. The devil might be in the details but short of a confiscation of private bank assets to provide relief to underwater homeowners, I don’t see how it would have been better.
I think ther are some things we could do NOW since we have a bit more time but back then… no, not really.
Strategic defaulters are no worse than corporations. So perhaps corporations aren’t people but some people are certainly acting like corporations. And frankly i don’t blame them. If I was stuck with a 500K mortgage on a 300K home, I might want to walk away and put that 200K towards my kids college fund, even if it meant I would be renting my home for the next 7 years.
I think banks could be handling the forecolure process a lot better. I think you have to be an idiot not to realize that this is going to be a multi year problem and that it might be worth hiring a few more people to help you deal with your REO property. I think its silly for a bank to let a couple of local real estate brokers convince them to sell a 500K home in a 500K neghiborhood to the broker’s cousin for 300K only to watch the cousin turn around and sell it for 450K, which mean the next home you forecole will only get 275K. If I was a bank I would put all my REO property into a REIT and rent it out. They would do a lot better doing that then dumping them after foreclosure. Maybe even rent them to the same people you foreclosed on, a strategic defaulter might be happy to do exactly that.
A lot of these things don’t work. Pay employers not to fire people? How the hell do you do that? Does the employer tell the government how many people they WOULD HAVE fired and get a check? Be specific about the sort of tax breaks and jobs programs you would have used because TRUST ME, they were really trying to lower the unemployment rate. I DO agree that private sector job growth has largely been negated by public sector job loss.
Treason? Really? How about just fraud? We already have a mechanism for taking over insolvent banks, not investment banks but would you really have wanted to take over bear stearns or lehman?
More like 1.3 trillion. And it wasn’t just subprime mortgages, there was a lot of alt A stuff that went into default within the first year.
And that is why we occupy wall street.
The state didn’t lose money.
There were in fact conditions placed on TARP money. If you sold mortgage securities to TARP, you couldn’t deduct salaries in excess of 500K and you couldn’t sign goden parachutes. If TARP bought your stock, then there were limits on bonuses. People were not generally taking bailout money and buying US government bonds, I think you may be confusing Open Market Operations of the Federal Reserve and activity at the discount window with TARP. The thing about the discount window is that you pledge Discount window - Wikipedia
There were strings attached btu I agree the conditions were far too lenient and there have been far too few prosecutions of fraud, conflict of interesta nd berach of fiduciary duty.
The wealth is already destroyed. The question seems to be who should bear the loss, the banks and their shareholders or homeowners.
The banks are not the free market equivalent of widows and orphans. They are not victims of the big nasty idividual homeowner. They knew, even better than those homeowners, what was going on and what theyw ere getting themselves into.
And I want banks to give 10% interest on my checking account and refinance my house at 1%, not really sure what your point is other than that banks want to make money. People can default if they choose. Defaulting is not against the law, there are consequences but its not illegal.
Well, the complaints I have heard from former Lehman folks is that treasury was littered with Goldman folks and this made it very eaasy for treasury to see the global financial system through the Eyes of Goldman Sachs and in their eyes, Lehman was an acceptable loss while AIG was not. Mostly because Goldman had very little exposure to Lehman but a LOT of exposure to AIG. If they had to do it all over again, they would have encouraged more of their folks to do a stint at Treasury.
Well, another way to deal with this would be through regulation of the financial industry but the industry has successfully purchased Republican support on this and all you can do is camp out on Wall Street.
You sure you aren’t an Occupy Wall Street type? It sure sounds like you are.
You can’t have a government run financial market, the entire point is that you need a LOT of market participants with skinj in the game and that is one thing a government bureaucrat cannot emulate at his desk. Better to have regulations and perhaps restrict some types of market activity because frankly some financial innovations are much better at creating risk and bonuses than stability and wealth.
LOL. Slight disconnection.
But it might be why there are no Detroits.
An open question to Voyager and others who seem to understand all this stuff quite well:
I guess I am largely confused about how this entire thing is set up.
From my understanding, the government wanted more homeowners in the US, and so they forced banks to make it easier for people to get loans. What I don’t understand is why they’d enact this without understanding that it’s a time bomb. If I keep lending money to people who are high-risk… I mean, shouldn’t this have been an obviously bad idea?
Here are my current interpretations that may need correction:
-
As far as I’m concerned, derivatives don’t actually add value. They’re just bets/hedges that shift risk from one party to another. There’s always a winner and loser, and so I don’t understand how value is made unless the winner does something with the earnings that is value-adding, etc. There was a lot of talk about how Goldman Sachs siphoned out a huge sum of money by betting the right direction in assuming the housing market was going to collapse. In other words, it’s like taking out an insurance policy on someone else’s loss. It’s like me being able to collect if your house catches fire and burns to the ground.
-
I don’t understand how ratings agencies slapped on AAA ratings to these securities when they actually weren’t. I don’t understand the justification for taking something that isn’t technically idiosyncratic risk and acting like it can be diversified away.
-
I don’t understand how lending to “deadbeats” turns a profit.
-
What was it that actually caused the collapse? I know prices suddenly plummeted, but why? Was it just an eventuality of the market, i.e. people were no longer willing to buy at those high prices? Why didn’t it just sink down slowly instead of drop like a stone?
I’m just trying to understand where the money’s coming from, where it’s going, and how value is created/destroyed either in terms of actual or opportunity gains/losses. I’d really love to learn more about the mechanisms behind the crisis because I feel there’s so much I don’t understand.
Two comments:
-
I don’t see any proof that US Debt shrunked based on those payments. Any information on that?
-
You seem to ignore the role of Federal Reserve in picking up “troubled assets” from various financial companies (Citi, AIG, Bear Sterns …) and paying for them with cash (out of thin air, of course). Take a look at Feds Balance Sheet. Where do you think these financial companies came up with billions of dollars in such a short order?
I’ve said repeatedly that the mistake was not slapping restrictions on the banks at the time they would have agreed to nearly anything to survive. But we have a bigger problem, which is the slow implementation of the rules that did get through thanks to a party who seems to be unhappy that the middle class didn’t get totally wiped out by the crash. Those who keep complaining about the bailout as a bailout (which doesn’t include you) either are so economically illiterate that they don’t know what would have happened or else would have preferred a Depression.
There is an additional reason. Much of consumer spending was funded by people taking what they saw as free money (the increase in equity) from their houses. When prices dropped, this spending dried up. Plus, they had to worry about the cashflow from these loans, something the ads never mentioned.
I need to clarify something for everyone. TARP was just one program out of several other bailout programs, approved by Congress with the intent of getting crap assets off the books of the banks to improve their balance sheet and hopefully encourage lending. It was not used for that purpose. It essentially ended up as a program to shore up the largest banks.
But there were numerous other “backdoor” bailouts of the banking system, perpetrated by the Fed. The Fed audit revealed that $16 trillion in emergency loans were made to prop up the banks, American and foreign. It’s really too much to get into here, but in broad terms:
-the banks have had access to interest free financing from the Fed, while paying miniscule amounts of interest to depositors because of ZIRP;
-they’ve been able to unload their crappiest assets onto the government;
-they’ve benefited from lax accounting standards (“extend and pretend”), meant to make their balance sheets look healthier than they actually are;
-they’ve mostly been allowed to continue with business as usual, making speculative bets in the market and paying huge bonuses while being propped up by the taxpayers.
To take TARP in isolation, and claim that the government turned a profit on the program, is pure obfuscation. We’ve all been conned. When you take government involvement in the banking sector as a whole, you find that the government and the taxpayer continue to be the lifeblood of the banks, that nothing has really changed and that we’re still at risk for another crash.
No, the government did not force banks to lend to bad risks. What they did do was to address either a real or perceived discrimination problem. Studies back then indicated that neighborhoods with similar income levels got treated very differently by banks depending on the ethnic makeup of the neighborhood. Ask anyone who claims that the government forced bad loans on banks to show you the specific clauses in the law which encouraged making loans with little or no downpayment and without documentation. Loans without documentation had a purpose, for freelancers and people with income but not a traditional paycheck. They were not meant for everyone. Plus, many of the worst offenders were not even banks and were not covered by CRA.
You’re confusing derivatives with insurance. Derivatives let people bet on the direction of a market without actually getting into the market, and thus provides more information about it. The problem was, as I understand it, that the derivatives were getting so complicated that not even the Fed Chairman understood them, and that derivative trades were not as open to scrutiny as stock trades. Insurance was supposed to reduce risk, but by allowing anyone to buy it it increased the downside risk. Getting premiums on very low probability events looked like a real good idea to the insurance companies, except that, as pTerry says, one in a million shots happen 99% of the time.
To extend on your example, let’s say an insurance company, to get more income, lets people buy insurance on any house in town. It sounds like a good idea, since historically only one or two houses burn in a year. However, if a house catches on fire during a period of high winds and the fire spreads the entire neighborhood, the insurance company is screwed, and that is more or less what happened.
The AAA ratings were not given to subprimes, but to collections of mortgages including subprimes. I believe that the rating agencies published their criteria, which let the banks put together packages as bad as possible to get a AAA. It might also be the case that the banks weren’t open about loan quality, but I don’t think I’ve seen hard evidence of that - but I believe it. Remember also that banks chose their rating agencies, so the agencies knew that if their competitors were going to give AAA ratings, they had better also.
Simple. Find a sucker to buy the loan which you are selling as having high return and minimal risk. In fact, if you are getting more money for loans to deadbeats, you will not only give deadbeats loans you will go out and find more deadbeats to lend money to - and also try to make non-deadbeats take deadbeat quality loans.
A sudden loss of trust. Once they recognized that the market could go down, behavior changed, and banks could no longer get money.
As for why there wasn’t a soft landing, Krugman was begging the Fed to raise interest rates to deflate the bubble slowly for years before the crash. But that would have reduced the profits for the banks, and Greenspan just didn’t believe anyone on Wall Street was greedy. No bank could do it, since if you eschewed this market your profits would not match those of your competitors, your stock price would drop, and the CEO would be out on his ear - especially if a year passed and everything looked fine. That’s why the Fed had to do it, and if you have someone like Greenspan in control it wouldn’t and didn’t happen.
I read about it in the Times and the New Yorker as it was happening, but there are lots of books out now. I can’t recommend a particular one - anyone have suggestions?
Thanks for the detailed response.
However, I am still confused on the first point. So there was a supposed discrimination problem. How did banks deal with it? It seems like on some level there had to be regulation to get banks to treat everyone “fairly” – but in what sense were policies changed so that things were “fair,” and how did that lead to the case where suddenly “loans were cheap to get” and people were living beyond their means on credit?
-
I understand that if the entire neighborhood catches fire, the insurance company is screwed, but how does the magnitude of “screwage” change by allowing people to make bets on things they didn’t put any skin into? For instance, if I buy insurance on my house, say I pay X so that I receive Y in the event of burndown. I am assuming that if everyone else buys insurance on my house for X, it’s not like EVERYONE receives Y because obviously number of people * Y > way more than the cost of the loss. Was the main problem simply having risk parameters adjusted because of speculators flooding the market and distorting the “true” values of things?
-
I see – thanks for the correction!
-
Still confused on this point. In my mind, “deadbeat” = someone who obviously can’t afford the loan or pay it back. If I give $100 to my deadbeat friend, I’m not expecting to ever get it back. Therefore I don’t understand how lending money to deadbeats is profitable in the first place.
-
How does raising interest rates deflate the bubble (I’m assuming this just makes owning a home more expensive?)? Weren’t interest rates REALLY low after the dot-com bubble burst? I remember hearing that technically we wanted to lower rates… even when we were already at or near zero. Not sure if my facts are straight and how this works. Did any of it have anything to do with government spending/taxation/deficit levels?
You lend $100 to your friend because he wants to buy a baseball card worth $110. At the end of the year, he’s supposed to pay you back $105. If he doesn’t, you can force him to sell the card, and get your $105 that way. So, it’s pretty much guaranteed that you’re going to make your 5 bucks.
On top of that, you have a big business going, so you package his loan with a bunch of others, and sell it for $101 two weeks after you make the loan. Quick $1 profit, no need to worry about pesky details like him actually paying you back at any time.
So to draw the analogy to the crisis, it’s lending money to people so they can purchase homes, bundling the mortgage loans together into a package and selling them off to make a quick buck – so it’s in your best self-interest to make as many loans as possible and to sell off the packages?
So ultimately, we’ve lent out a lot of money to people, and there are many parties who own these packages. A lot of these guys are going to default, and so it sounds like a game of hot potato where the person holding the loan bundles gets screwed as he now holds a package of worthless IOU’s. Is that the gist of it? If so, why would anyone develop such a system? Is it really as simple as tragedy of the commons/self-interest at the expense of the whole?
The $16 trillion number is so misleading it borders on fiction. The misnamed “audit” revealed that a $1 billion overnight loan rolled over 30 days was accounted for as $30 billion in loans.
No foreign banks were loaned to. Royal Bank of Scotland is a US chartered bank just as domestic as Bank of America is. The parent banks might be foreign.
Banks have $1.6 trillion on reserve at the Fed today and it pays only .25 of one per cent interest while loans to banks are virtually nil.
No assets from banks were sold to the Fed other than Maiden Lane - a one-time sell to fence off Bear Stearns bad debt. It is small compared to the other Fed buys - all Treasuries and agency (GSE) MBS.
“extend and pretend” is a euphemism for mark-to-market which has been FASB compliant since 1993 - which itself is GAAP compliant. The Balance sheets are excellent at the big banks.
No large bank is currently propped up by taxpayers. In fact, if they fall below a certain core asset quality level - they will be forced into liquidation thanks to Dodd-Frank. Resolution (liquidation) is required by law now.
I bet I can name some blogs you have gotten this erroneous info from.
You’re parroting Bernanke’s position.
Read Bloomberg’s response to that, read some commentary here. The $16 trillion was the GAO’s figure. Even if you don’t agree with their method of accounting, Bloomberg’s method (which did not tally cumulative loans) still came to a figure of over $7.7 trillion.
And foreign banks most certainly did get money from the Fed, among them large banks such as UBS and Royal Bank of Scotland. Read Matt Taibbi’s article for the fun version. This was all revealed by the Fed audit.
The full, implicit backing of the government and the taxpayers has sustained the banks and allowed them to continue business as usual. It’s indisputable. The Fed will do everything in its power to prevent the TBTF banks from having to be subjected to a Dodd Frank resolution. Your entire post was pure financial industry shillery.
ETA: Here’s the GAO report for anyone insane enough to want to read through it:
LINK (PDF)
This is all petty far over my head, but this is clearly wrong or being mis-characterized here:
[QUOTE=MOIDALIZE]
Read Bloomberg’s response to that, read some commentary here. The $16 trillion was the GAO’s figure. Even if you don’t agree with their method of accounting, Bloomberg’s method (which did not tally cumulative loans) still came to a figure of over $7.7 trillion.
[/QUOTE]
From your link:
-XT
That’s because it involves things such as asset swaps and guarantees, not solely loans. But if the Fed buys garbage assets from the banks, it’s certainly of benefit to the banks.
So saying “$16 trillion in loans” was inaccurate on my part. “Benefits” or “financing” is probably more accurate.