Professor Mark J. Perry's Blog for Economics and Finance
"Take Wall Street "greed." Is there any evidence that people on Wall Street were any less interested in making money during all the decades and generations when investments in housing were among the safest investments around? If their greed did not bring on an economic disaster before, why would it bring it on now? As for lenders, how could they have expected to satisfy their greed by lending to people who were not likely to repay them?"
Dr. Mark J. Perry is a professor of economics and finance in the School of Management at the Flint campus of the University of Michigan. Perry holds two graduate degrees in economics (M.A. and Ph.D.) from George Mason University near Washington, D.C. In addition, he holds an MBA degree in finance from the Curtis L. Carlson School of Management at the University of Minnesota. In addition to a faculty appointment at the University of Michigan-Flint, Perry is also a visiting scholar at The American Enterprise Institute in Washington, D.C.
27 Comments:
Arthur Bentley's classic book "The Process of Government," published around 1900, begins by pointing out the absurdity of citing changes in people's basic wants as explanations for events. Unfortunately, politicians love that sort of argument; we got it from both candidates in the last presidential election, and we'll probably get it from both next time around, too.
If you read the Partnership (A history of Goldman Sachs) you see the orientation change from making money by doing a good job for clients to makeing money any way possible. So yes the making money was always there, but it has moved to the top rung which is a sign of getting ready for a fall. Making money should always be about doing the basic job right and then come along for the ride.
Swing and a miss by Sowell.
The influence of Wall Street is the problem. Their influence prolonged the disaster as long as it didn't hit them.
Nice point, Alan.
Wall Street is kind of a special case because they have such a strong incentive to distort information. The "Greed is good" mantra mostly does work where information cost is low. If everyone tries to get the best deal they can, but can't effectively lie, the system works relatively well. But when bankers can pass on crappy loans just by buying a good rating for them, we get big messes.
"...how could they have expected to satisfy their greed by lending to people who were not likely to repay them?"
I like Sowell's quotes for the most part. However, a lot of the mortgages in this category were securitized and sold off. You make a profit from the loan without having to worry about whether or not the loan will go into default.
It isn't Wall street vs Main street, it is Main street and Wall street vs Pennsylvania Avenue. Easy money policy led to a housing bubble, and banks fell victim to the bubble just like others, but the government bailed them out. Who is at fault for both the problem and the bad solution? Government.
Seth, so are you saying that citizens should not have a say in their government? Sounds like it. The problem is not Wall Street's influence on Government, but Governments influence on everything.
Paul Volker is the wise voice in separating commercial banks from trading firms. Goldman Sachs did not fail but got billions to stay in business. If the taxpayer is the backstop from calmaity then casino type trading need not guarantee re-payment for gambling losses.
Charlie Munger has written a very dark parable in the latest Slate on the U.S. which is quite grim about its future. This is very surprising considering his success based upon his past confidence. For those that don't associate his name readily: He is Vice Chiarman of Berkshire Hathaway and Chairman of Western Asset Management.
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The problem wasn't that banks made bad loans and sold them, the problem was that other banks (and the government) bought them. That was stupid and those banks that bought a pig in a poke should have been allowed to fail. This was not a lack of government regulation, but rather bad investments and the results should have been the same as for other bad investments. If anything, it was government policy that encouraged and then ultimately mitigated these bad investments.
"As for lenders, how could they have expected to satisfy their greed by lending to people who were not likely to repay them?"
Hmmm...perhaps because they had planned to hold these mortgages in portfolio for only a short time, only to sell them off.
They had no skin in the game, and even U Chicago people know that.
--Pingry
Correction: Charlie Munger, the author of the parable on how one country came to financial ruin, is Chairman of Wesco Financial Corporation and Vice Chairman of Berkshire Hathaway.
Hmmm...perhaps because they had planned to hold these mortgages in portfolio for only a short time, only to sell them off.
And who did they intend to sell them too? Fannie and Freddie who wound up purchasing more than 2/3 of all subprime and Alt-A mortgages. Unfortunately, the government's recklessness did not stop there as this CATO article reveals:
Astute readers will smell a connection between the Recourse Rule and the financial crisis. By 2008 approximately 81 percent of all the rated MBSs held by American commercial banks were rated AAA, and 93 percent of all the MBSs that the banks held were either triple-A rated or were issued by a GSE, thus complying with the Recourse Rule. According to the scholars I mentioned earlier, the lesson is clear: the commercial banks loaded up on MBSs because of the extremely favorable treatment that they received under the Recourse Rule, as long as they were issued by a GSE or were rated AA or AAA.
A Perfect Storm of Ignorance, CATO
And just how did the GSE's get a AAA rating on the MBS that they created and sold? They lied about the credit scores of the mortgage holders:
New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.
[...]
The credit score threshold for conventional mortgages, which had generally been 670 or more, dropped to about 630. In the real world, a score of 630 indicates that you’re having trouble with your debt load, paying your bills on time, or a little of both.
More ominously, the credit score threshold for subprime mortgages, which had generally been 630 or more, fell to about 590. A score of 590 is the credit scoring equivalent of barely having a pulse.
The Price for Fannie and Freddie Keeps Going Up, WSJ
Wall Street was simply satisfying a demand created by government. To blame these firms - which is what the politicians responsible desperately want you to do - for the crisis is just ignorant.
They had no skin in the game, and even U Chicago people know that.
If they had no skin in the game, then what happened to Merrill Lynch, Lehman and Bear Stearns?
"Swing and a miss by Sowell"...
Hmmm, three strikes in a single swing by sethstorm...
Amazing!
Can you say, "Community Reinvestment Act"?
Nothing like throwing a little social engineering into the market place, eh?
Quote from sethstorm: "The influence of Wall Street is the problem."
Who is really the problem? Those trying to buy influence, or those selling it (the same people who've sworn an oath to the Constitution)?
"Five of the nine living former Treasury Secretaries support the Volker Rule." The stakes are high for the traders and they should be allowed to fail -- government programs and guarantees are too intertwined costing the U.S. trillions.
Fannie Mae, Freddie Mac, TARP, CRA, FHA, FDIC are programs that need to be surgically separated and wound down except for FDIC. All of these programs along with combined Banks and Traders (ie. Bank of America) make for a guaranteed excess of risk for ever higher alpha rewards.
"If their greed did not bring on an economic disaster before, why would it bring it on now?"
1) less regulation
2) lots more leverage
3) securitization (sell the crap to someone less sophisticated before it blows up)
4) false sense of security from increasing use of unregulated CDS to insure the crap they were peddling
Anonymous at 11:51 hit the ball out of the park.
Juandos hit a long foul ball. While CRA was a symptom of the national housing frenzy and putting special interest politics ahead of prudent business practices, CRA is simply too small an impact to account for a significant part of this crisis. The entire government apparatus devoted to housing, including Fannie, Freddie, government tax breaks and subsidies, government loans, "affordable mortgages" and artificially low interest rates caused this.
Sethstorm fouled the ball into his head and knocked himself out.
juandos said...
"Swing and a miss by Sowell"...
Hmmm, three strikes in a single swing by sethstorm...
Amazing!
Can you say, "Community Reinvestment Act"?
Nothing like throwing a little social engineering into the market place, eh?
Agree with Juandos. Sethstorm commenting on Sowell making a swing and a miss is pretty funny stuff. Seth needs to spend $25 and buy Sowell’s book Intellectuals and Society. Maybe Seth needs to study this link and pay attention to Sowell’s 30 years ago among the discussion group members:
http://miltonfriedman.blogspot.com/
Thomas Sowell is too smart to be putting out straw men arguments like this.
Washington let the monkeys out of their box and they ran rampant across the economy. Put the box back and let them risk only their own money. Cost of capital will spike and these bright smart people will find more productive uses of their time.
Q: If their greed did not bring on an economic disaster before, why would it bring it on now?
A: No one was watching this time.
The severe recession and slow recovery could've been avoided, even with the moral hazard of "too big to fail."
The correction took place suddenly rather than slowly (after Lehman failed), and the recovery is taking place slowly rather than suddenly (because it's a consumer-driven economy rather than an export-led economy), which caused a lot of idle resources.
Wall Street doesn't have a monopoly on greed. It just deals with more money and spreads the risk to other greedy people.
"CRA is simply too small an impact to account for a significant part of this crisis"...
Hmmm, you know this how Flora?
The problem is government intervention in the market place, an overiding intervention that skews the market conditions...
Consider the following from the Business Insider: David Rosenberg: Get Ready For The FHA To Go Completely Bust And The Housing Market To Take The Hit
Maybe Rosenberg is wrong but the problem still exists, we taxpayers will end up footing the bill if the FHA does have problems...
Its not like we haven't seen this problem before...
This Just In: "Treasury to resume the monetization of the Fed's Balance Sheet to support Wall Street Banks".
As Jesse (Jesse's Cafe American) explains " This Treasury supplemental financing program is designed to provide funds for the Fed's efforts to purchase and liquidate toxic assets and derivatives from the financial sector effectively absorbing their losses and monetizing them.
This is my third comment so this may be my third strike or I might be hitting at least .333!
Hey sethstorm, John Stossel has found your perfect country....
You make a profit from the loan without having to worry about whether or not the loan will go into default.
Not so. Securitizers demand repo agreements. If the loans enter default too soon, the seller has to buy the loan back. Since a defaulted loan is worth quite a bit less than what it originally sold for, you lose big money selling a bunch of bad loans. That's why so many banks and Wall Street houses are going bankrupt. If it were as you say, the only people going bankrupt would be the bondholders.
The banks are in trouble due not to getting securitzations back (execept for SIVs and the like that were shams in the first place), but in at least Lehmans case having a lot of inventory of the stuff when the music stopped and not being able to unload it. They got to the point where they liked their toxic junk so much they kept a good bit of it. (Thought the interest rate was good)
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