October 3, 2008 11:01 AM
Arnold Kling hits the creation of the secondary market for mortgage loans as the major factor -- 50 percent — causing the current financial crisis. As Kling wrote:
In hindsight, I think that the crisis was caused by
a) creation of the secondary mortgage market (50 percent)
b) low down payment mortgages (30 percent)
c) the "suits vs. geeks" divide (15 percent)
d) other (5 percent)
The more I think about the secondary mortgage market, the less I like it. Any widespread benefits, such as lower mortgage interest rates, are microscopic. On the other hand, several times (not just recently), the market has been used to create or enhance regulatory loopholes that undermined the safety of the financial system as a whole.
I am surprised that Kling so lightly dismisses the benefits as “microscopic” of one of the most positive innovations in the mortgage market. Just think about it. Financial institutions — primarily savings and loans -- prior to the creation of the secondary market, took in short-term deposits and made long-term, fixed-rate loans (30 years). Until the early 1980s, Regulation Q set the limit on the interest rates that could be paid on deposits.
October 3, 2008 10:37 AM
The politically dangerous $700 billion financial system bailout bill is getting even more expensive as supporters load it up with pork to get wavering Congressmen to switch their vote and support it. (It passed the Senate overwhelmingly on Thursday, but was narrowly defeated in the House on Monday).
In addition, the bailout bill has been expanded to make the FDIC insure deposits up to $250,000, rather than the current $100,000. This is a bad idea, since the overstretched FDIC barely has enough resources to cover the first $100,000. The Wall Street Journal today explains just how costly and risky it is to increase the FDIC limit, and predicts that it will "encourage riskier lending behavior."
Also in the Wall Street Journal, economics professor Russell Roberts explains how government regulators stoked the mortgage bubble, which now has imploded into a financial crisis.
The bailout bill itself may lead to inflation and future bubbles. And it may not do much to unfreeze credit markets, as the failure of European bank bailout measures shows, and as former Bush Treasury Secretary Paul O'Neill has warned.
October 3, 2008 9:11 AM
ACORN is speaking against it—maybe it will actually help! This past summer Congress passed “Hope for Homeowners” which took effect Monday. Distressed borrowers can now refinance into 30-year fixed mortgages with the backing of FHA. According to the Boston Globe,
To be eligible, the borrower's home must be the primary residence; the mortgage must have originated on or before Jan. 1, 2008; and as of March 2008, an applicant's mortgage payment must account for more than 31 percent of gross monthly incomeâ€¦.The mortgage servicer must be willing to take a loss and write down the loan - insured by the Federal Housing Administration - to 90 percent of the home's current appraised value. If the home is sold, the homeowner must agree to share any appreciation with the FHA and the refinancing lender. The program, authorized by the Economic and Housing Recovery Act of 2008, will be in effect through Sept. 30, 2011.
And yet, the used car salesmen on the Hill don't want to let Hope for Homeowners or the changes to Mark to Market accounting have their effect. Instead, Pelosi is asking Blue Dogs to take one for the team and hope that defaulting on their “PayGo” promise won't have the same result as “No New Taxes” did.
October 2, 2008 3:45 PM
It will actually divert money to the Treasury from commercial lending. Naked Capitalism has more, concluding:
When Paulson dumps out his 700 billion in treasuries it's going to be at the short end. That will drive up rates for short-term treasuries. This will obviously draw even *more* deposits into the treasury MMs. That means even less in the commercial MMs and thus less working credit, the eventual commercial MM product. Hence Paulson's billions remove working capital by competing for the deposits that could get used to make working capital loans. That 700 billion is going to go to fairly long-term mortgage securities. So Paulson's billions divert credit from working capital to long-term mortgages - from where it's most needed to where it's most wasted.
Even if the giveaway adequately props up the banks, which I doubt, they still can't make working capital loans, because the raw material they used (commercial MM deposits) will be desperately short.
I think it's very telling that in two days of hearings and two weeks of discussion we have yet to see *any* detailed mechanism for how Paulson's plan will increase the supply of, say, inventory loans. It's not that every economist in the world is an idiot, it's just not going to help. I think people have fallen into the fallacy that if it costs a lot it must be valuable. Paulson's plan falls into the category of very expensive way to hurt ourselves.
October 2, 2008 3:18 PM
At least in its original form, the $700 billion bailout bill was unconstitutional because it gave the Treasury Secretary boundless discretion to buy, or not buy, bad loans at whatever suited his whims, without providing for judicial review. More recent versions of the financial-system bailout bill may have added a little bit of judicial oversight (rendered almost meaningless by virtue of the minimal, vague, and conflicting statutory criteria they provide), but they have not changed the fact that the bill remains politically dangerous.
If the bailout bill passes (as seems likely), businesses seeking to sell their bad loans will have a powerful incentive to ingratiate themselves with whoever is president, and whoever is the Treasury Secretary, by making political donations and engaging in influence-peddling. Expect vast political donations to the President and his party from banks and lenders if the bailout bill passes, effectively drowning out the voices of the American people.
The incoming administration may be able to use it as a form of political patronage, effectively operating as a political slush fund for favored lenders. During the New Deal, the government used welfare programs to essentially buy votes in swing states. As a result, even though the U.S. economy recovered more slowly from the Great Depression than from prior sharp recessions, and even though it recovered more slowly than the economies of other Western countries which rejected big-government responses to the Depression (like Great Britain, where public employee salaries were cut), the incumbent administration was reelected an unprecedented four times.
October 1, 2008 11:24 AM
Banking expert Peter Wallison explains why deregulation didn't cause the financial crisis, while Steven Malanga explains how government regulators foolishly pressured banks to drop prudent lending criteria as "discriminatory," resulting in risky lending that caused the crisis.
October 1, 2008 10:07 AM
As a $62 trillion dollar over the counter market, CDSs need an exchange or central clearinghouse to provide transparency and collateral requirements. CME (formed from the Chicago Board of Trade and the Chicago Mercantile Exchange) and the Clearing Corp (formed from 17 financial players including UBS and Goldman Sachs) have stepped up to the plate. Clearing Corp could have had a clearinghouse up and running within a week or so; however, the Fed has pushed Clearinghouse to obtain a banking license which will probably delay its opening until next year. But with each bank that is removed from this house of cards the threat of meltdown is increased. The banks are falling one after another internationally, and with the CDSs so intertwined, its only a matter of time until when you take away one more card and they all fall.
According to Bloomberg, "Barclays analysts estimated in February that if a financial institution that had $2 trillion in credit-default swap trades outstanding were to fail, it might trigger between $36 billion and $47 billion in losses for those that traded with the firm. That doesn't include the market-value losses investors face as the cost to protect companies against a default widens."
Perhaps it would be a good idea for the Feds to speed their approval process?
October 1, 2008 3:59 AM
As the Wall Street crisis has expanded, politicians are falling all over themselves arguing on behalf of the "little guy" against "fat cats." But in reality, the main elements of "rescue" plans receiving a bipartisan push would represent a massive transfer of wealth from little guys and gals to fat cats' pockets.
First, there was Treasury Secretary Hank Paulson's $700 billion bailout the House defeated on Monday, but to be revived in the Senate as early as Wednesday night. Then there is the upper-income wealth transfer that will now be added as the cherry on top of this bailout: raising deposit insurance to bank accounts of $250,000 or more.
According to the Associated Press, both Barack Obama and John McCain on Tuesday backed lifting the deposit insurance cap to $250,000 from the current $100,000 maximum. And Federal Deposit Insurance Corporation Chairwoman Sheila Bair wants Congress to give the FDIC "emergency" authority to raise the cap to any level she deems necessary to "restore confidence" in the banking system.
But wasn't too much confidence in the banking system in large part what got us into this mess? Deposit insurance, even at current levels, encourages "moral hazard" as consumers assume their banks are totally safe and don't look for quality as they do with investments and so many other products.
And I'm sorry, but if you were fortunate enough to inherit or sophisticated enough to accumulate more than $100,000, you don't need the extra protection from other taxpayers. How hard is it, under the current system, for folks with $250,000 burning holes in their pockets to find three different banks to put it in?!
September 30, 2008 7:34 PM
Rigid mark-to-market accounting rules may have triggered the current financial crisis by artificially undervaluing mortgages and securities (making financial institutions appear insolvent). Even the very government officials who have advocated those rules now hint that they will disregard them in valuing the government's own mortgages, in administering any bailout! (This inconsistency undermines arguments for the bailout).
The SEC today made federal accounting rules a bit less rigid by allowing methods other than mark-to-market accounting in appropriate conditions. Thus, when mortgages have not defaulted, financial institutions need no longer treat them as worthless, even when no active market exists for the security based on those mortgages.
September 30, 2008 11:58 AM
The People have spoken. They have picked the Market over the Government to be the chooser of winners and losers.
Here are the Market's choices for winners:
1. Those that live in their homes, versus those that purchased houses to be flipped (third letter).
2. Homeowners that purchased a house that they could afford with a 30-year fixed, versus the over-extended with an adjustable rate.
3. Small local banks that didn't make ARM loans with no money down, versus big ones with mortgage-backed securities.
4. Those that saved their money, versus those betting on the stock market.
5. Those who pay for their cars with cash, versus those who finance them.
6. Those who pay for their expenses with cash, versus those who run up credit card debt.
7. Those who save money for their kids' college funds, versus those who rely on loans.
8. Those who chose preferred stock, versus owners of common stock.
9. Those industries that are needed by and contribute to today's economy, versus those that rely on subsidies voted for them by politicians.
10. In the global market—the Market will choose economies that have less debt and low inflation, versus big spending governments with easy monetary policy.
In general, the Market will choose the prudent. Who would have the Government picked as winners? The Market's choices for losers. The Bailout would have picked all of the losers above.
Risk is not immoral: everyone should be able to invest as they choose, but they do so at their own risk.