Stats Analysis of TARP = Paying for Type I Errors
Arnold Kling analyzes the subprime mortgage mess using statistics:
Null Hypothesis: Borrower applying for a loan will NOT repay it.
Alternative Hypothesis: Borrower will repay the loan.
Type I Error: Rejecting the null hypothesis when it is actually true, in this case approving a loan that eventually goes into default.
Type II Error: Accepting the null hypothesis when it is in fact false, in this case denying a loan to a borrower who would actually repay the loan, or making an "error of excessive skepticism," i.e. having credit standards that are too strict.
Other things equal, if a bank tries to make fewer Type I errors by imposing strict credit standards, it will make more Type II errors (rejecting good loans).
Other things equal, if a bank tries to make fewer Type II errors (by lowering credit standards), it will make more Type I errors (accepting bad loans).
In 2004-2007, Freddie Mac and Fannie Mae lowered their lending standards. This meant approving loans with lower FICO scores, along with other methods (mortgage underwriting is based on a number of factors). At the hearing, Congressmen were asking (not in these words), why did you succumb to pressure to reduce Type II errors and increase Type I errors? (MP: By relaxing underwriting standards).
The CEOs said that the market was changing. In the past, when they made Type II errors, nobody saw them. If Freddie and Fannie denied a loan, then the loan was not made. Wall Street was now making loans to borrowers with lower FICO scores, and these borrowers were not defaulting. The Type II errors that Freddie and Fannie were making were more visible than they had ever been before. This made the CEOs question their own credit policies, and they decided to loosen up.
As it turned out, the success of Wall Street's looser lending policies had been due mostly to luck--rapidly rising house prices. Once house prices stopped rising, Wall Street's loans started defaulting. The large number of Type I errors had been exposed. Meanwhile, Freddie and Fannie had loosened up at just about the worst possible time--just as house prices were reaching their peak. They made a lot of Type I errors, for which we as taxpayers are going to pay a steep cost.
HT: Club For Growth
9 Comments:
Very interesting way of expressing the problem using Stats language. Great post.
The Real Estate value decreased because that is what Real Estate does. It is a cycle and always has been.
Dating back to 1962, each down cycle has lasted longer then the previous down cycle.
Nothing here is new except for the USA is now a warehouse for the worlds junk, driven by consumers who produce almost nothing and have Government mandates to make a large percent of loans to people who could not afford adjustable loans in an economic period of inflating consumer prices.
Here is the crash point. Hippies would not allow drilling for oil (in California the building of new power plants and Refineries). Here comes $145. Dollars per barrel for a commodity which will kill an economy the moment the cost should exceed $86. Dollars per barrel.
The problem was NOT a normal Real Estate Down cycle. The problem was a economy who exported as many jobs as it could to support the environmental Gowds, did not plan for our own energy needs to drive an economy and insisted our Middle Class work force compete for jobs in our own Country with third world labor.
Can anyone offer any explanation for a Government who has exported every Manufacturing job with in their power to export from the USA and are now looking to save the Big 3. Why? The only reason I can see for the DNC to save the Big 3 would be pay back to the Mobster Unions.
I thought the Socialists would be happy to see the remaining Manufactures leave.
Hotrod.
Subprime loans will always underperform prime loans, ceteris paribus.
The inferior terms guarantee it.
Anonymous said:
"
Here is the crash point. Hippies would not allow drilling for oil (in California the building of new power plants and Refineries)."
How did Hippies get that kind of power?
> The CEOs said that the market was changing. In the past, when they made Type II errors, nobody saw them. If Freddie and Fannie denied a loan, then the loan was not made. Wall Street was now making loans to borrowers with lower FICO scores, and these borrowers were not defaulting. The Type II errors that Freddie and Fannie were making were more visible than they had ever been before. This made the CEOs question their own credit policies, and they decided to loosen up.
And I'd ask -- how does the falsified financial statements which OFHEO brought to Congress in 2004 (and which the Dems swept under the rug while pillorying the OFHEO auditors) filed by Raines and Gorelick (which got them their bonuses in the tens of millions and more) -- how did that affect the appearance of things?
I have no direct data, but if the falsified report directly led to the decision by the lenders to lower their standards, then we have a direct connection between the fraud of Gorelick and Raines and the current credit problems.
String the bastards (Raines and Gorelick) up. They did nothing that Ken Lay and his ilk did not do, for exactly the same reasons -- personal benefit.
I want their testicles ripped off.
> The problem was a economy who exported as many jobs as it could to support the environmental Gowds,
No, not buying this argument any more than I do the whole "exporting" argument in the first place when the libtards first started whining about it...
We are transitioning from a manufacturing economy to an IP and Services Economy.
Not more than 2% to 5% of the US population should be involved in manufacturing. Roboticization should be doing the exact same thing to manufactured goods that mechanization did to farming.
And in both cases, the margins are and should be slender and only encourage economies of scale for such stuff. If other nations with less advanced economic systems want to bootstrap themselves up using their people, much as the USA has done, and that's cheaper than robots, so far, then more power to them.
But the idea that ANY jobs in manufacturing are being unnecessarily lost overseas is patently ignorant of a pattern which has been happening ever since the 1960s, when we became fully industrialized... after that timeframe, everyone started talking about the "Post-Industrial World" -- "post-" means "after, but we don't know what it is yet".
Well, we know what it is -- IP and Services. That's where all new wealth is going to come from. And arguing for the maintaining of manufacturing jobs is flat out stupid.
> How did Hippies get that kind of power?
WhoTF let a complete scumbag like Bill Ayers become a full professor at a significant University?
How does he continue to keep that position at a private university?
Simple -- They got older and stealthier. That's often the way it works.
The reversal of the process isn't going to be easy if it's possible at all. We've let the libtards get in complete control of the educational chain, and they're creating an army of libtard idiots to follow in their wake.
The question now remains...Who should foot the bill for the unpaid debt? If I had known Uncle Sam would be picking up the tab, I would have bought a bigger house.
When everything was becoming more mechanized and computerized, a serious question arose. That question was, "What are people going to do with all of that extra spare time?" Here we are in the 21st century and I haven't seen any of that "extra spare time."
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