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Source link: http://archive.mises.org/13686/the-rock-was-thrown-up-but-it-is-falling-down-again/

The rock was thrown up but it is falling down again

August 24, 2010 by

Existing Home Sales Plunge

{ 89 comments }

michael August 24, 2010 at 12:52 pm

Back when the market was hot, lenders made extravagant loans to unqualified applicants, then bundled and securitized them to sell them off while the low introductory payments were flowing in. The unknowing home buyers were living in more home than they could afford… but wouldn’t know that yet for another couple of years when the rates ratcheted upward.

It’s a different ball game now. You can’t sell off a bad loan any more. So lenders are being super cautious. THAT is the reason home sales are slow. When you restrict the market to only the very best among the qualified applicants, there aren’t that many families whose applications can be found acceptable.

Considering the slump in the job market, with no relief in sight, I would guess it will remain that way for a while yet.

J Cortez August 24, 2010 at 2:27 pm

michael said: Back when the market was hot, lenders made extravagant loans to unqualified applicants, then bundled and securitized them to sell them off while the low introductory payments were flowing in. The unknowing home buyers were living in more home than they could afford… but wouldn’t know that yet for another couple of years when the rates ratcheted upward.

You sound as if you’re blaming the lenders. The lenders were stupid, but so were the buyers. It takes two to tango. The lenders were looking to sell the securitized mortgage and the buyers were looking to quickly flip a house after a year of appreciation. A better thing to look at is how was this environment created in the first place?

Bottom line, all of what you’re talking about was subsidized, encouraged, made possible by the government and its related agencies. By the FDIC, Treasury, Fannie Mae, Freddie Mac, and the Federal Reserve. To give an indication of how lost the people in those agencies are, about a year before everything fell apart, when asked about a possible housing bubble, Fed and Treasury officials said it didn’t exist.

A wide scale fractional reserve banking system that is dependent on a central bank like the Fed is the problem. Not, “the lenders.” This entire thing can only be a surprise to anybody not paying attention.

michael said: It’s a different ball game now. You can’t sell off a bad loan any more. So lenders are being super cautious. THAT is the reason home sales are slow. When you restrict the market to only the very best among the qualified applicants, there aren’t that many families whose applications can be found acceptable.

You can’t sell a bad loan anymore? Home sales are slow because bad deals don’t work anymore? I’m sorry, but that’s a good thing. Bad deals are what caused this mess, so why would you want to continue with that idiocy?

Restricting the loanable funds to qualified applicants is what should have happened instead of the malinvested garbage of the past few years. The correct reason home sales are slow is because there is a gigantic oversupply that was built up over the past decade, not because of a return to realistic lending standards.

michael August 24, 2010 at 2:39 pm

Those lenders were anything but stupid, Cortez. They made out like the bandits they knew they were. OF COURSE a banker knows when he’s originating a bad loan. That’s why they sold off those hot potatos pronto, before they exploded in someone’s hand.

The NINJA loans didn’t self-destruct until the rates adjusted. They were deliberately made affordable for the first 2-3 years, so default rates remained low and consequently the securities that were based on them enjoyed high ratings. The scam was elegance itself.

You are correct that one consequence of the market that grew around this practise was a huge oversupply of newly constructed, still available homes. It will take years to take up this slack.

Phinn August 24, 2010 at 3:02 pm

The credit ratings agencies are so thoroughly entrenched and controlled by government regulation (one major round of legislation was inflicted in the mid-1930s and another set of major regulatory changes in the 1970s). They cannot be considered “private” companies, any more than banks can.

Banks are not legally permitted to invest in anything that the handful of government-approved agencies says they can. This makes the CRAs essentially a government-sponsored ratings cartel, and it effectively protects them from any competition from small, upstart, private ratings agencies that would attempt to offer any serious competition to the cartel.

As a result of this insider-favoring regulation, the CRAs shifted from a business model where the investor pays for the information (and thus pays well for reliable, accurate ratings), to one where the debtor pays. Naturally, as one would expect, this means that the ratings are inflated.

Once again, the government has destroyed the pricing mechanism, in this case by protecting CRAs from economic pressure that would have forced them to be accurate or fail.

J Cortez August 24, 2010 at 3:07 pm

michael said: Those lenders were anything but stupid, Cortez. They made out like the bandits they knew they were. OF COURSE a banker knows when he’s originating a bad loan. That’s why they sold off those hot potatos pronto, before they exploded in someone’s hand.

This is exactly senseless. Having worked in real estate, I can tell you the majority of the lenders had no idea about the consequences of their subprime business. Anybody that had major exposure to subprime got hurt. About 250-300 banks have been shuttered since all this started. How is that good business strategy? The only people that benefitted from the mess were the select dozen or so firms that had the political connections (Goldman Sachs, JP Morgan Chase, BOA, etc) to get bailout funds either from the Treasury or the Fed.

michael said: The NINJA loans didn’t self-destruct until the rates adjusted. They were deliberately made affordable for the first 2-3 years, so default rates remained low and consequently the securities that were based on them enjoyed high ratings. The scam was elegance itself.

The credit rating agencies were a requirement of the Basel I & II regulations, which were in turn required by the Treasury, SEC, and related agencies. You know, the same agencies that dropped the ball after they created this mess? The thing is you, by law, had to use those credit rating agencies. As it always happens when you get monopolies on a particular product or service, the price rose while quality was near non-existent. The ratings were garbage, but hey it’s ok, the Treasury and the SEC say everything fine, so let’s go.

Also, Ninja loans only came into existence because money was cheap thanks to the Fed’s monetary inflation and low 1% interest rate. Be sure to thank Freddie and Fannie as well, since they pushed for lower lending standards since the late 1990′s which, along with the low rates, contributed to the creation of a no doc, no income, no job, and no asset loan market.

The only scam in this case is the government agencies that say that somehow this was all the markets’ fault.

michael August 24, 2010 at 3:33 pm

“Having worked in real estate, I can tell you the majority of the lenders had no idea about the consequences of their subprime business. Anybody that had major exposure to subprime got hurt.”

I believe you, Cortez. Only a minority of lenders were crooks. But the problems were created by a few big time operators, the Anthony Mozilos of the world. They were able to move mountains of money into fraudulent financial instruments, and peddle them through the offices of unscrupulous traders. The numbers involved were almost beyond belief.

“The only people that benefitted from the mess were the select dozen or so firms that had the political connections (Goldman Sachs, JP Morgan Chase, BOA, etc) to get bailout funds either from the Treasury or the Fed.”

Far from the only people… but they took advantage of the general duress and gained mightily by it. Let’s say they were the principle beneficiaries of the bailout, as well as its orchestrators. There were also millions of lesser winners in this game.

As to the rest of your comment, you’re generally correct. Easy money became the crack cocaine fueling this lending binge.

Dagnytg August 24, 2010 at 4:40 pm

When you restrict the market to only the very best among the qualified applicants, there aren’t that many families whose applications can be found acceptable.

Your statement may be true among private banks (if there is such a thing) but the majority of loans (around 90%) are FHA loans…

I’m not sure what your definition of “the very best” is but if you have a credit score above 600 (or no credit score at all) you can still qualify for a 3% loan (and the 3% down does not have to come from your savings) not to mention some 100% loan programs are still available.

I could describe more bizarre details (like counting college or continuing education in lieu of job history) but anyone can google it.

Needless to say, I believe there will be more foreclosures in the future from these new buyers.

J. Murray August 24, 2010 at 1:06 pm

It seems our esteemed government officials never heard of front loading.

Bogart August 24, 2010 at 1:07 pm

In the long run we are all dead!!!!
And unfortunately have extremely short life expectancies.

cafeLiberty August 24, 2010 at 1:26 pm

Haha. I guess this means a permanent first time home buyers credit for years to come!

J. Murray August 24, 2010 at 1:28 pm

Makes me wonder what they’ll cook up when there are no more firsts to buy homes. Second home buyer credit?

Statureman August 24, 2010 at 2:49 pm

Don’t give them any ideas.

Phinn August 24, 2010 at 1:35 pm

“lenders made extravagant loans to unqualified applicants”

This bust wasn’t merely the result of making loans to unqualified applicants. Yes, that was one component of the aggressive subsidization of credit to housing lenders, but not the sum total of it.

A much larger effect of the government-sponsored expansion of housing credit was that the amount of money that middle-class buyers would be loaned was also greatly increased. These were people who were otherwise qualified to obtain a loan, but would have bought a far less-expensive house. With the government’s backing, the size of their loans were inflated.

That artificially-accelerated cash-flow drove a lot of other businesses — the furniture, housewares and home renovation industries; relocation-related business (including insurance, since agents get paid by commission for originating new insurance policies, which happens less when people don’t move as often); not to mention the realtors, mortgage brokers, real estate lawyers and title companies who took part in those inflated transactions directly.

michael August 24, 2010 at 2:31 pm

Phinn: You’re right on target. The central element, though, was that after all the legitimate loans had been made to qualified borrowers, the banks still had plenty of money left over. They had to do something with it. So they originated an entire new market: greatly expanded subprime programs flying under the radar of government guaranties.

One thing all that money did was to drive interest rates down… which had the fortunate effect of forcing up the size of the loans applicants were able to obtain. That made new home prices rise inordinately… and fed the dream of miraculous appreciation. Every real estate bubble depends on the notion that home values inflate faster than do any other prices in America. And that consequently one’s equity multiplies faster when sunk into one’s home than it does when invested anywhere else. So it’s easy to sell people way more home than they need. What they’re buying is an investment account they can also live in as it appreciates.

Among the hogs feeding at the trough were developers and builders, and the many owners of raw land who sold off grand daddy’s homestead to live like Beverly Hillbillies. But there were also millions of smaller beneficiaries, the ordinary roofers, electricians and pipe and cable installers who gained steady work in the boom.

Phinn August 24, 2010 at 3:09 pm

None of these effects was “fortunate.” The entire economy was polluted with malinvestment — bad financial and economic decisions that rippled all the way from the lenders to the borrowers to the plumbers. Government interfered with the pricing mechanisms that people based their financial decisions on. As a result, they were deceived into buying things they should not have bought, starting businesses they should not have started, building houses they should not have built, hiring people they should not have hired. It was not sustainable. Government-sponsored booms never are.

J Cortez August 24, 2010 at 3:17 pm

Phinn, isn’t it funny how some people praise the boom, despise the bust, and then want to continue the same bad behavior that created the bust in the first place?

As I’m sure you know, but our friend michael doesn’t– continuing the same bad policies is just going to make the bust worse.

michael August 24, 2010 at 3:45 pm

“.. isn’t it funny how some people praise the boom, despise the bust, and then want to continue the same bad behavior that created the bust in the first place?”

Cortez, I think you misunderstand me greatly if you think I approve of anything about what happened. Maybe I should have added more emotion-words when describing it… but I thought words like “scam” were sufficient to convey my moral judgment.

Even beyond this particular boom, which was actually a criminal adventure, I disapprove highly of anything the RE industry does that stimulates hothouse growth in home prices. Such growth is unsustainable, it leads to a more general price inflation and it deludes millions of people into making bad mistakes with their savings. It’s all bad… except for those millions of jobs that were created to feed the beast.

There’s a second misunderstanding I didn’t comment on earlier:

michael said: “Back when the market was hot, lenders made extravagant loans to unqualified applicants, then bundled and securitized them to sell them off while the low introductory payments were flowing in. The unknowing home buyers were living in more home than they could afford… but wouldn’t know that yet for another couple of years when the rates ratcheted upward.”

Cortez: “You sound as if you’re blaming the lenders. The lenders were stupid, but so were the buyers. It takes two to tango. The lenders were looking to sell the securitized mortgage and the buyers were looking to quickly flip a house after a year of appreciation.”

Here you and I were talking about two entirely different sectors of the housing boom. I was discussing the offering of exploding (variable rate and ballooning) subprime mortgages to unqualified applicants. You are discussing speculators in ultra-hot markets, like Vegas, Florida and California. Once prices began rising up to 50-100% a year, the high-end market changed as a lot of people with cash to play the houses started plunging in the flip market.

You’re right about them. But I think we should separate these two phenomena for clarity’s sake.

michael August 24, 2010 at 3:24 pm

I used the word “fortunate” with tongue in cheek. It was fortunate for the schemes of the perpetrators that they could drive up mortgage amounts by driving down interest rates. They couldn’t lose either way circumstances dictated they go.

And it may surely be that government-backed mortgages lead to malinvestment in some purist sense. But they had the practical effect of creating, as much as any other factor, America’s bottomless fount of wealth for the common man. Without government loan insurance, very few among us owned their own homes. But with the advent of the FHA and VA loan programs, a whole new industry based on massive home ownership was born. Millions became employed in new construction, millions more bought their own homes and entered the middle class. And so long as the major players remained honest, no money was lost.

It was a golden era… until the crooks took over. Then we started having serious structural problems like the S&L debacle. Of course the government could have just let everyone crash and burn in 2007, when the subprime scam began to surface. In that event we’d have had no economy at all by 2009. The dominos were falling all over the globe.

J Cortez August 24, 2010 at 3:49 pm

michael said: And it may surely be that government-backed mortgages lead to malinvestment in some purist sense. But they had the practical effect of creating, as much as any other factor, America’s bottomless fount of wealth for the common man. Without government loan insurance, very few among us owned their own homes. But with the advent of the FHA and VA loan programs, a whole new industry based on massive home ownership was born. Millions became employed in new construction, millions more bought their own homes and entered the middle class. And so long as the major players remained honest, no money was lost.

This is one of the greatest fantasies I’ve read today. First, government actions within a market economy always causes a distortion. What is key is how it is done and by what order of magnitude.

In previous posts you complained about the evil of packaging and selling mortgages on the secondary market. The problem with this is the secondary market was created by programs like the FNA, FHA, etc. In fact, the largest holder of mortgages are those agencies.

Re: Home ownership and the “common man” –whatever the hell that term even means. There is a huge misconception about home ownership as if it is some perfect panacea to all problems of family wealth. It’s not. Homes are just places to live. The fact that everybody started to use the like credit cards in a Fed induced, manic, low interest rate world, was not a great thing, it was a problem.

Millions employed in a malinvested distorted economy is never a good thing. If you really want to keep people employed, let’s abolish all cars, burn down all houses, and outlaw shovels. I assure you, in that scenario, there would be a lot of work around. But of course, you’d have a massively jack up and contorted market. My example is overdramatic, but the premise is sound. Any intervention is undesirable, and under the policies you speak of, there would be massive problems.

Instead of tinkering with policy, the market should have been left alone. No intervention means no distortions, no malinvestments, and a sustainable economy. The question to ask yourself is do you want a fake economy or a real one, because sooner or later the mirage disappears.

michael August 24, 2010 at 4:11 pm

“This is one of the greatest fantasies I’ve read today. First, government actions within a market economy always causes a distortion.”

This is an article of faith I’m sorry to say I don’t share.

It is also a tautological definition. If you want to define ANY government involvement as a distortion, I suppose that’s your fancy. But for consistency’s sake you would have to start with the issuance of money. And if our economy is at its very root distorted by government-printed scrip and government-delineated lending policies, then there’s nothing you can say. It’s all either a self-correcting unitary system, both public and private at the same time, or a funhouse room full of mirrors, depending on how you want to portray it.

When the government took a postwar economy they weren’t sure might slide back into depression and created an insurance program for home loans, they turned that into the greatest engine for the creation of middle class wealth the world had yet known. And I wouldn’t call FHA-VA any kind of distortion. It was an insurance program, one that could have been created by anyone commanding sufficient resources. The US government was just the first to happen to do it.

And those programs didn’t lose a dime, for many years. Let’s just leave ideology for those really egregious cases, where it fits.

But I know, you want a REAL economy. The first thing you’ll have to do is take all your Federal Reserve dollars out in the back yard and burn them. They’re instruments of the Devil.

Phinn August 24, 2010 at 3:55 pm

I do not know what “malinvestment in some purist sense” means.

Malinvestment is not a matter of purity or impurity. It is a practical reality — people use prices to decide what economic activity to engage in, both as a matter of production and consumption. Prices tell people what they can afford to buy, what to produce, what kind of business to go into, how to run that business, how many people to employ, when every single business decision is profitable and when it is not.

This is what Hayek meant when he said that prices are signals. People base their decisions and their behavior on signals. When you tinker with the signals, you alter people’s economic behavior. They can no longer accurately discern the profitable actions from the wasteful ones, or measure the risks. It’s like trying to build a house with a framing square whose measurement marks keep stretching and squeezing, and a level that can’t tell up from flat. You end up with a wonky house.

This is not purism. This is reality, up close and personal. Manipulating prices (especially the price of credit) has an immediate, practical effect on people’s perceptions of economic profits and losses, and thus an immediate effect on their economic choices and behavior.

they had the practical effect of creating, as much as any other factor, America’s bottomless fount of wealth for the common man

Clearly, it’s not bottomless. It has run out.

Without government loan insurance, very few among us owned their own homes.

As the result of government loan insurance (and other manipulations), very few among us own the home we would have owned. Many have been lost to foreclosure, and more are coming. Most people who bought in the last 15 years over-bought and over-paid, because the prices of ALL houses were manipulated upward. These manipulations did not make housing more affordable. They made it less affordable.

But with the advent of the FHA and VA loan programs, a whole new industry based on massive home ownership was born. Millions became employed in new construction, millions more bought their own homes and entered the middle class.

That economic activity was based on the illusion created by manipulated credit and distorted prices.

And so long as the major players remained honest, no money was lost.

Untold trillions were lost. People were deceived into building and buying houses that the economy as a whole could not sustain. Those wrong decisions were wasteful, but people didn’t know it at the time, because the (inaccurate, manipulated) prices told them the lie that their building and buying activities were profitable.

The bust has revealed all of those cumulative errors.

michael August 24, 2010 at 4:22 pm

“The bust has revealed all of those cumulative errors.”

Real estate has gone through a great number of cycles in recent centuries. And it may be that with each revolution of the great wheel, it reveals its errors and inconsistencies to those who’ve been watching it closely. But few are those who’ve been around more than once. So the woods are still full of a more than sufficient number of suckers eager to play the game. Always.

Let me just say it’s simplistic and doctrinaire to exclusively blame the federal government for everything. The greed that feeds on the mirage of appreciation is very much a private vice. And the industry that fuels all those hopes and dreams is also a private one, motivated by the handsome profits standard real estate practise makes accessible. It is true that in its lobbying arm, the industry is able to assure its continued existence by influencing favorable legislation.

As as for the banks? Did you know they were Number One? In pure lobbying clout, they lead the pack by quite a margin. They are followed by health care (#2), the farm lobby (#3) and the military-industrial sector (#4). Yes, it might surprise you to know all those sectors get to write their own legislation.

In such a rigged game it’s all malinvestment. You can’t just pick and choose which parts are okay and which are bad. It’s potentially treacherous terrain, all of it.

Phinn August 24, 2010 at 10:30 pm

In such a rigged game it’s all malinvestment.

Yes, it is! Every manipulation of the economy that you listed, at the behest of the cronies and the insiders, is an act of violence and theft by the government-lobbyist symbiont (because at that point, they are really acting in concert, as one unit, against the interests of everyone else).

Every single one of these anti-free-market acts of legislation and regulation constitutes Statist violence, and therefore by definition causes a net loss of prosperity and economic improvement that flows directly from the freedom to trade voluntarily and peacefully.

mr taco August 24, 2010 at 10:32 pm

michael i was beginning too worry about you ; )

michael August 25, 2010 at 6:29 am

“Every single one of these anti-free-market acts of legislation and regulation constitutes Statist violence, and therefore by definition causes a net loss of prosperity and economic improvement that flows directly from the freedom to trade voluntarily and peacefully.”

How is it, then, that our economy has been polluted from top to bottom with a hundred years of statist intervention and a policy of unlimited creation of Monopoly money, and the end result has been that we have had the strongest, most stable economy on earth for the past sixty years? And that the US dollar is the currency of choice for everyone on the planet to use as their safest store of wealth?

Matthew Swaringen August 25, 2010 at 6:39 am

“How is it, then, that our economy has been polluted from top to bottom with a hundred years of statist intervention and a policy of unlimited creation of Monopoly money, and the end result has been that we have had the strongest, most stable economy on earth for the past sixty years? And that the US dollar is the currency of choice for everyone on the planet to use as their safest store of wealth?”

You are calling this stable after pointing out the instability that lead to what we have now? Contradictory at all? I’d say yes. Furthermore, I imagine one who also thinks that the income gap is larger than it should be, and yet you don’t blame that on the creation of monopoly money but on market transactions agreed upon by individuals alone? I think that’s ridiculous.

The fact that some (definitely not everyone on the planet as you put here) use US dollars instead of their own countries currency is not a beacon of our success due to manipulations, it’s that the manipulations we’ve had are relatively small in comparison to those of many other nations. Second, the entire “stability” is built on a house of cards. The liabilities we’ve stacked up during “stability” aren’t going away. Our stability was in large part thanks to the Chinese and others for providing us goods far cheaper than we should have received and keeping their own people poor through devaluation of their own currency.

Bala August 25, 2010 at 6:54 am

michael,

” How is it, then, that our economy has been polluted from top to bottom with a hundred years of statist intervention and a policy of unlimited creation of Monopoly money, and the end result has been that we have had the strongest, most stable economy on earth for the past sixty years? And that the US dollar is the currency of choice for everyone on the planet to use as their safest store of wealth? ”

Are these outcomes because of or in spite of the interventions?

michael August 25, 2010 at 7:10 am

“You are calling this stable after pointing out the instability that lead to what we have now? Contradictory at all? I’d say yes.”

It’s all relative, Matthew. I said we had the most stable economy on earth, referring here to our domestic economy. Relative to, say, the Europeans, we’re the place overseas dollars go to invest themselves. That’s why when this latest bubble broke, one of the first big victims was Germany’s Deutsche Bank. And of course Iceland and Ireland, both big plungers in American real estate via the massively bloated derivatives market.

Let me ask you this: since the dam broke, has there been any great capital flight out of US markets?

And a followup: if global investors thought there was anything fundamentally unsound about America, wouldn’t there have been?

Instead, not only are overseas dollars staying in the game, US Treasury offerings are getting snapped up basically at par: near-zero interest rates above inflation. Even the ten year rates are uncannily low. What do you think is going on here?

I’m thinking a majority of investors don’t share in your calamity theory. They’re all putting their money where their mouth is. (I will admit, in a very real sense they had to; US financial markets were the only game in town, other than direct purchases of American assets.)

“Furthermore, I imagine one who also thinks that the income gap is larger than it should be, and yet you don’t blame that on the creation of monopoly money but on market transactions agreed upon by individuals alone? I think that’s ridiculous.”

No matter how much easy money you put into the system, it gets injected at the top and it stays at the top. There is no mechanism for it to ever descend to the middle and lower levels. Only wages and salaries, and those are kept low by the law of supply and demand in the labor market.

So it’s only ridiculous if you try to force it through the meat grinder of your philosophy. Looking at reality straight on, we can say that on the fortunate level, we are awash in floods of unearned money, and that these sodden fields are constantly being watered by Federal largesse.

Yet at the same time, the majority of the public, not having access to such beneficence, is trying to claw its way back from a ledge of consumer debt. It came about because while they had no ability to OWN any of that money, they were still urged to borrow all they wanted, and to just pay it back in a leisurely fashion… at 29% interest.

I see no inconsistency.

J. Murray August 25, 2010 at 7:15 am

There’s a big difference between being safe and being the least harmful. Keeping capital in the USA is nothing more than the least of all evils.

michael August 25, 2010 at 7:20 am

“Are these outcomes because of or in spite of the interventions?”

Hello, Bala. I couldn’t venture a guess. All I know is that our economy has been managed very closely since 1913, “managed” being the word I use in place of “market intervention”. And the result has been a total triumph for the Almighty Dollar over every other currency on earth.

Is our economy flawless? I would never make such an absurd argument. The rules of the game are set in place by the game’s winners. They whisper into the ears of Congress the rules they want to be “forced” to follow. And surprise, surprise! Those rules merely enhance the accretion of wealth into the same few pockets. Congress gratefully accepts their emoluments, licking the fingers of their sponsors for bits of gravy. It’s all a very smarmy game, in which the public is the perpetual loser.

michael August 25, 2010 at 7:25 am

“There’s a big difference between being safe and being the least harmful. Keeping capital in the USA is nothing more than the least of all evils.”

So you agree, JM, it’s all relative. We are the least shaky, best managed (that is, the most intervened upon) home to be found for capital on this earth. We are Number One.

Too bad most Americans would be willing to perform the experiment you so desire: to just let go of the reins and find out where the mad dash of runaway horses would lead us. I don’t think many would have the stomach for anything like that. But it would illustrate for all time whether or not such a course was folly. And the austrians would all then either be elevated to marble pedestals or hanged from lampposts.

Jon Leckie August 25, 2010 at 8:18 am

michael, one way or another we’re going to see whether the US economy remains the global powerhouse it was for the 50 years after WW2. We are going to see. My fear/expectation is that the US is heading for a big slow steady dive, but as I’ve posted previously, it’s not going to be cataclysmic, just a long steady decline. US federal debt is not irrelevant and for so long as Capitol Hill takes no action to get it under control, the reserve currency status that has allowed the US to rack up debts beyond what is sustainable by any other economy will be steadily eroded. You guys have a monster on your hands there, and neither side of politics seems at all concerned about it.

I have always loved America. I think it really is the finest country on earth, although I’ve not had the opportunity to spend as much time there as I would like. The productive and creative potential of your country has changed the world and has set an example to others. However the values that made it great are under dire threat, and the source of the threat is the size of the federal government. There has to be a sea change in the way folks view the problem, which is why sites like mises.org are so important. I fear that if America continues down it’s current path, America’s fine example to the rest of the world will only be found in the history books. I sure hope I’m wrong.

And it’s not just America, btw. I have read somewhere (I can’t recall the source) that the Liberal/Conservative Howard government in Australia passed more pages of legislation and regulations in its 10 years of power than were passed in the previous 90 years of the history of the Commonwealth of Australia. That’s a doubling of the rules regulating human behaviour in a decade. It’s incredible, and it has to stop.

mpolzkill August 25, 2010 at 8:24 am

“sites like mises.org are so important. I fear that if America continues down it’s current path, America’s fine example to the rest of the world will only be found in the history books. I sure hope I’m wrong.”

You’re not wrong, sorry to say, Jon. And you’re also so right about Mises. That is the only battle really left, the one over the history books, and it’s Mises vs. professional liars like Michael here.

michael August 26, 2010 at 9:06 am

“michael, one way or another we’re going to see whether the US economy remains the global powerhouse it was for the 50 years after WW2. We are going to see. My fear/expectation is that the US is heading for a big slow steady dive, but as I’ve posted previously, it’s not going to be cataclysmic, just a long steady decline. US federal debt is not irrelevant and for so long as Capitol Hill takes no action to get it under control, the reserve currency status that has allowed the US to rack up debts beyond what is sustainable by any other economy will be steadily eroded.”

Jon, the global credit markets are a confidence game, just like any other market. When investors have confidence, the markets are buoyed up. And when they don’t, the markets plummet. So let’s take a look at the health of the global dollar-based economy, in light of present fiscal policies.

How are ten- and twenty-year Treasuries doing?
http://www.forecasts.org/interest-rate/20-year-treasury-bond-yield.htm

Current yields don’t look too shabby. But what are people paying for bond purchases now?
http://www.treasurydirect.gov/RI/OFNtebnd

Hmmm… 30-year bonds have been going for 3.875%. It doesn’t look like the planet’s big-money crowd is particularly worried about the end of Dollar World.

These people have been around the block before. And when they crunch the current projections on our debt, and temper them against our current and likely future fiscal policies, they really don’t seem all that worried. Not over the next thirty years.

“You guys [us Yanks] have a monster on your hands there, and neither side of politics seems at all concerned about it.”

They would get alarmed in a heartbeat if Treasuries were to hold an auction and no one came. In such an event, the Fed would naturally step in and take up the slack so the entire offering was sold. But a signal would be sent to the market that next time, rates would have to be considerably higher to attract actual, not virtual, investors. And that would wreck our federal budget in a really scary way.

We owe the world a lot of money. Which we don’t mind and they don’t mind; we are their bank. In purchasing Treasuries they are betting on America as it is and is likely to continue to be. But if they were ever to lose confidence, we would see instant and cascading effects. For one thing, the sum we spend annually on interest payments would skyrocket and finish the job of swamping the budget. A slight hike in the rates we have to pay results in a significant cash hemorrhage; a doubling of the interest rates would be catastrophic. The resulting mess would snowball throughout the economy.

So it’s a constant nagging worry, that such a thing might happen. But at present, we seem to be nowhere near that point. I like to track where we are by reading the financial pages in Asia Times. They’re a really good indicator of the world financial mood.

mpolzkill August 26, 2010 at 9:10 am

That’s not what a “confidence game” is, you prattling buffoon. I’m sure the rest of this latest pile was of as much value.

Donald Rowe August 24, 2010 at 4:12 pm

michael,

You had me going for a bit there. I thought you were beginning to see that there are many ways to view a given situation and that your chosen viewpoint informs your understanding of it.

Then, Wham-O. You come out with this:

“Of course the government could have just let everyone crash and burn in 2007, when the subprime scam began to surface. In that event we’d have had no economy at all by 2009.”

Really? Rationalizing your support for our elected leaders, yet again, I see.

Cordially,
Don, your life boat buddy.

P.S. I have not forgotten my promise to you to try to explain anarchy in such a way that you may be able to accept the value of it. It’ll be ready soon. I’ll provide a link to it on some dead thread.

michael August 24, 2010 at 4:34 pm

Don: With a totally open mind, I would invite you to describe our situation, summer of 2010, had there been no bailout. Would we not have crashed and been burning?

Not that we’re doing at all well now. I’m hardly waving the flag for our economy under current leadership. But let’s imagine a scenario in which ALL the major banks had fallen and become insolvent. Would that not have been a mite worse?

As for anarchism, it’s a fine solution for a simpler society. I like a guy like Nestor Makhno, my kind of anarchist. Had it not been for the Bolshies and the Whites overwhelming his people’s movement he’d have created the very best solution for the Ukraine back in 1922: self rule.

But I’m dubious about anything like that working in a modern economy. First, everything that’s now maintained would have to collapse. And next, savagery would follow, as raw hunger and the survival mechanism made brutes of us all… and made the worst of men the best of brutes.

You might have missed my comment in another recent thread, where someone extolled Somalia as being a model of an unplanned economy. My response was to cite a news report to the effect that all of Somalia, save for a few blocks in downtown Mogadishu, is now run by al-Shabab. It’s a fundamentalist theocracy run by teenagers with Kalashnikovs. The quintessential non-state.

I don’t need it. I’m way too comfortable here. Cheerio.

Donald Rowe August 24, 2010 at 4:49 pm

michael,

I quite understand your viewpoint. I agree with you that our situation is bad. But my deep fear is that we will look back upon *today* with nostalgia.

“I’m way too comfortable here.” My hope is that you remain so.

I hope I can present anarchy in a new light, in spite of all its baggage and misrepresentation. It is a bit of a challenge to explain something that the listener has preemptively decided is *nothing*. I fear that I am not up to the task. Oh well.

Cordially,
Don

Donald Rowe August 24, 2010 at 5:03 pm

Nestor Makhno = fail

michael August 25, 2010 at 8:03 am

Donald: Makhno was defeated by a superior military force during a time of great disruption. Do you then hold him, his ideals and his movement in contempt? If so, it would follow that you hold the Bolsheviks in high regard.

Ukrainian society was at the time abused by czarist rule and then shattered by war. As an agrarian village society they would have benefitted well from self-rule within a traditional kolkhoz structure. Lenin’s mobs overran the country because Russia needed the food supply Ukraine provided. And because the Ukraine was a necessary square to capture in the chess game being played with Germany.

Even had Makhno momentarily prevailed, such an anarchist movement was out of step with the modern world. Any such ideal state would quickly have been overrun by the Germans.

So I would agree, if we were all still frontiersmen tending our corn patches in the Virginia piedmont, an agrarian anarchist society would be ideal for us. You’re going to have to hurry up a bit with your explanation of how one would fit in with the world of the 21st century. :)

Donald Rowe February 24, 2011 at 3:18 pm

michael,

Soon is a value judgment.

Anarchy, the New High Ground, an Open Letter to Michael, Part 1.html

Here is the link.
http://docs.google.com/document/pub?id=1arfFGLmIYf4P2CywtPOBtXIfOdkqiPsq3V1GCs7U1Pk

Best wishes and happy reading,
Don

Jon Leckie August 24, 2010 at 3:23 pm

Hi michael, hope you’re going well with Hayek. You say above “The central element, though, was that after all the legitimate loans had been made to qualified borrowers, the banks still had plenty of money left over. They had to do something with it.”

Question for you: where did all that money come from? What caused the excess? Now I think the answer “Damn Chinese save too much, need to buy more TVs” is a load of baloney, and fortunately there’s another cause that I have my eye on. Can you guess what it is?

Jon Leckie August 24, 2010 at 3:27 pm

Other folks might get sick of me constantly going on about the Econostories Hayek v Keynes rap battle on youtube, but they really did nail it:

Freddie H:
The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust
Of my theory, the capital structure is key.
Malinvestments wreck the economy

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

Your so-called “stimulus” will make things even worse
It’s just more of the same, more incentives perversed
And that credit crunch ain’t a liquidity trap
Just a broke banking system, I’m done, that’s a wrap.

michael August 24, 2010 at 3:58 pm

Hi, JL. The answer you’re looking for, of course, is that the Fed held an open line of credit for its “best customers”. But I’m thinking few of those best customers were directly involved in originating NINJA loans, selling $300,000 mansions to po’ folks who should have stayed renters. That kind of thing was mostly done, to the best of my knowledge, with investor money and profits looking for a home.

Please recall that Federal Reserve activities were far from being the only game in town. Banks were making humongous profits in their ordinary activities, like credit and debit card servicing. Plus, freelance investor groups have always been a major source of venture capital in the home mortgage market. And those guys bring their own chips to the table.

Were I to look for federal involvement in creating the mess I’d cite the dropping of firewalls between the commercial banks and the investment banks (Gramm-Leach-Bliley). This was a VERY bad piece of financial wiring.

As for Hayek, I’ve been kind of busy. I’m reading the guy, a chapter at a time. But it’s like eating a pound of oatmeal for breakfast.

JGiles August 25, 2010 at 7:28 am

Michael, I think you’d be wrong in that. A lot of the Fed’s “best customers” WERE, in fact, heavily involved in subprime loans and other unsustainable practices.

Of course, there was lots of private money too. But that’s kind of exactly what we mean when we say “malinvestment”; the distortion caused by government policy makes things temporarily profitable which weren’t, and shouldn’t be. This draws private money; that’s what inflates the balloon. But the point is that the private money wouldn’t have been there if the Fed hadn’t been throwing cash into the market.

Private investors don’t just suddenly all go stupid for no good reason. When a few million people all turn off their brains at once, which is what a depression is, there has to be a reason. That reason is manipulation of the market; signals are distorted, so of course people make the wrong decisions. How could they do otherwise?

michael August 25, 2010 at 8:13 am

Okay, Giles, I’ll go along. Private parties with the wit to make lots of money suddenly went silly, because the government made them do it.

I’d have said that they went with what had traditionally been a safe market offering good returns (mortgages) wrapped up in a trendy new package they looked upon as being sexy (mortgage-backed securities). And they did so under the naive assumption that if the insurance markets were willing to back it and the ratings agencies extolled its virtues, it must be idiot-proof.

Of course they didn’t know two things. First, they didn’t know that AIG offered no real insurance and held no real reserves. And second, they didn’t know the mortgage market. If I were to purchase one mortgage I’d go out to the house and get to know the customer. It wouldn’t be hard to tell whether he was a good risk or not. And if I were to purchase an interest in a derivative investment based on 100,000 mortgages, I’d still want to assure myself with solid answers to the same question: would he still be good when the rates reset and his payments went up forty percent one month?

Fools and their money are soon parted. A lot of people should have done their homework… but instead find it convenient to blame the federal gubmit for making them exhibit bad judgment.

JGiles August 25, 2010 at 8:42 am

Absolutely right. And I am not defending the decisions of all of the people who expanded the bubble; they were foolish.

But they were foolish only in that they trusted too much. The government assured everyone that the rating agencies were 100% trustworthy, despite obvious conflicts of interest. In fact, the government was so sure that it FORCED anyone who wanted their product rated to use one of a small number of government-guaranteed agencies, all of which turned out to be hopelessly corrupt, or at least incompetent. The government created a oligopoly, and then was shocked, SHOCKED, when it provide the service it was intended to.

In short, the foolishness you’re referring to is that the people trusted the government. I agree; that was stupid.

The banks, it must be said, practiced outright fraud. There’s no question about that. But how could so many banks get away with such blatantly misleading practices for so long? I would say, the main reason is that no serious competition was allowed to challenge them. In a competitive market, with a dozen hungry rivals eying your every move, you can’t practice banking fraud. The first time you do, your jealous enemies release a flurry of accusations and lawsuits. You lose trust and therefore market share, and your honest rivals gain. A competitive bank survives by cultivating scrupulous honesty and customer loyalty. Only in the kind of artificial oligopoly that the banking industry is today can these kinds of predatory practices flourish.

The banking sector was not only allowed, not only encouraged, but actually MANDATED by, yes, the government, to make subprime loans. In short, they were forced by their Federal overseers to take losses. Then some bright banker somewhere thought up the mortgage-backed security, and look! The government didn’t mind THAT at all! So the banking sector made terrible loans to the poor, making the government happy, and then bundled and sold them for billions of dollars, making their shareholders happy.

Everyone was happy. . . well, except for those people in homes they couldn’t afford, struggling to make payments. And those people foreclosed on, who couldn’t find a place to live because real estate was so expensive now. And those people trying to make a living honestly in banking, watching their dishonest competitors rewarded with massive profits while government regulators forced the honest bankers to take loss after loss on subprime loans.

In that sort of regulatory environment, I must say that I’m not at all surprised that the major banks rapidly grew stupid. The smart, honest bankers were GONE. The smart ones that stayed on were crooked, and the honest ones were dumb.

Did the government “make” people stupid? Not at all. But whatever its intentions were, the government DID create an environment which rewarded thievery and discouraged sound banking practice.

mpolzkill August 25, 2010 at 8:48 am

Stop whining, Giles, and vote the right Democrats (the defenders of “The People”) in. That’s how our system works.

JGiles August 25, 2010 at 11:08 am

Minor change; insert “could not” before “provide” in the last sentence, second paragraph of the post at 8:42 AM.

@mpolzkill; I think you mean, “that’s how our system DOESN’T work”, since changing the particular politicians in charge doesn’t actually solve anything.

michael August 26, 2010 at 9:43 am

Giles, you’re straining way too hard to portray The Government as the chief culprit in everything that ever goes wrong, in comments like this:

“The government assured everyone that the rating agencies were 100% trustworthy, despite obvious conflicts of interest. In fact, the government was so sure that it FORCED anyone who wanted their product rated to use one of a small number of government-guaranteed agencies, all of which turned out to be hopelessly corrupt, or at least incompetent. The government created a oligopoly, and then was shocked, SHOCKED, when it provide the service it was intended to.”

No, it’s just the way the market is structured. Buyers wanted some reliable source of information to guide them in identifying solid investments, so they created a need for services like Moody’s or S&P. Then, quite naturally, they wanted the backup assurance of a cop to certify that the ratings agencies they used were above board. So they felt more comfortable with the assurances of the SEC. That’s the kind of thing investors demand: someone to put a seal of approval on every claim of worthiness they read, and someone else to put their certification on the issuer of the seal of approval. This is not just some government plot to subjugate us to their whip.

Then, of course, the structure got subverted. Bond ratings agencies got themselves captured by the very interests they were designed to police, in the wake of Gramm-Leach-Bliley. In the words of Wikipedia,

“Until the early 1970s, bond credit ratings agencies were paid for their work by investors who wanted impartial information on the credit worthiness of securities issuers and their particular offerings. Starting in the early 1970s, the “Big Three” ratings agencies (S&P, Moody’s, and Fitch) began to receive payment for their work by the securities issuers for whom they issue those ratings, which has led to charges that these ratings agencies can no longer always be impartial when issuing ratings for those securities issuers. Securities issuers have been accused of “shopping” for the best ratings from these three ratings agencies, in order to attract investors, until at least one of the agencies delivers favorable ratings. This arrangement has been cited as one of the primary causes of the subprime mortgage crisis (which began in 2007), when some securities, particularly mortgage backed securities (MBSs) and collateralized debt obligations (CDOs) rated highly by the credit ratings agencies, and thus heavily invested in by many organizations and individuals, were rapidly and vastly devalued due to defaults, and fear of defaults, on some of the individual components of those securities, such as home loans and credit card accounts.”

The USG was not the principal instigator of this failure to properly police. They were the tool of those creators of debt instruments who wanted to fly fast and loose, free from any real financial oversight. And they paid well for the regulation they received.

“In short, the foolishness you’re referring to is that the people trusted the government. I agree; that was stupid.”

I doubt that anyone was really misled merely because he trusted the government with such implicit faith that he never questioned authorities like S&P. That’s beyond being a stretch. Naivete was involved, to be sure. But it had to do with individuals’ failures to understand the full workings of the markets. Also, they may not have fully trusted even the assurances of the ratings agencies. But in trying to dig deeper they came up against the inherent opacity of information available even to the well-informed public. There was information one couldn’t buy anywhere.

And meanwhile there was the allure of something sexy and available, the promise of vast returns if one were a member of the Smart Money, clad in silk smoking jacket and slippers, well above the plebeian world of ordinary investors. The issuers of all this fraudulent crap were peddling the sizzle, more than the steak.

Damn that US government! for making us buy all this worthless junk!

michael August 26, 2010 at 9:59 am

“The banking sector was not only allowed, not only encouraged, but actually MANDATED by, yes, the government, to make subprime loans. In short, they were forced by their Federal overseers to take losses.”

This is a thin reed; a tired canard that doesn’t stand up to scrutiny.

The CRA was written into law back in 1977. And for a generation it worked as designed, failing to produce any outstanding crop of bad subprime loans. The loans originated under the act all performed about as well as comparable, non-CRA loans. Investors were not only happy, they were safe. The Community Investment Act was not at fault.

Then around 2002-04 unscrupulous lenders found and exploited loopholes no one had found before. And also, by then, CRA had undergone innumerable updates and alterations at the hands of the financial lobbyists who insert such amendments into any regulatory act that serves its purpose too well.

So what happened next? At first the NINJA loans went well. Borrowers were able to pay the low introductory rates on ridiculously advantageous loans. And then, in the third year, those loans reset. And suddenly, to the great alarm of all those millions of financial nonsophisticates, they found they could no longer afford to stay in homes they couldn’t keep up the payments on.

That’s what happened. Blaming CRA is a self-serving justification to once again be able to divert attention from the real causes, and away from the connivers who eventually find a way around or through every net designed to snare them.

JGiles August 26, 2010 at 10:00 am

Michael, I’m sorry but you’re simply wrong.

The agencies I’m referring to are “Nationally Recognized Statistical Rating Organizations”, which are credit rating companies which have been given the SEC’s stamp of approval. this began in 1975; these are NOT a recent invention of bankers, they are a pure government construct.

Basically, the SEC decided that if a bank was heavily invested in “safe” securities, then it could be exempted from some capital reserve requirements; that is, practice fraud. It picked out a few rating agencies and sent them a “No Action” letter, which said that if financial organizations broke the capital requirement laws, but used ratings issued by these particular agencies as justification, they wouldn’t be prosecuted. People using ANY other agency to do something similar WOULD face federal charges.

These agencies include Moody’s, Standard & Poor’s, and Fitch, the three of which control basically all of the credit-rating market in the USA. This is the very definition of a government-created oligopoly.

So yes, the government is, in large part, to blame. And this isn’t even considering the rest of my points; banks were legally required to make subprime loans which did not make financial sense. This naturally led to a scramble to find some way, any way, of making money off these bombs, which lead to the rise of CDOs where the worthlessness of the paper could be hidden under AAA ratings from the (yes, government-accredited) NRSROs.

mpolzkill August 26, 2010 at 10:02 am

Oh yeah.

I was just trying out the rhetorical trick of anticipating and slightly exaggerating the standard tactics of the enemy, Giles.

Tom DiLorenzo just made a related post:

http://www.lewrockwell.com/blog/lewrw/archives/64391.html

[wish I could find the video]

JGiles August 26, 2010 at 10:11 am

In response to your last comment; ok, so “unscrupulous lenders” will find a way through “every net designed to snare them”?

Then WHY KEEP WEAVING NETS?

The whole PREMISE of Austrian economics is that people are greedy and unscrupulous, Michael. In a truly free market, that tendency works FOR the good of society, not against it.

Government gives greedy, unscrupulous people something to grab, something to twist, something to use to give themselves an advantage.In a free market, there isn’t any of that. There’s just you, your competitors, and your customers; and you can never fool all of the people all of the time. Dishonest business practices give a lever to your competition and drive away customers. It’s only when dishonesty can be concealed under a cloak of legalese that it can do as much damage as we’ve seen the last few years. The “nets” of government regulation only give the greedy and unscrupulous a way to climb the ladder of profit faster than their honest competition.

The dishonest distort the market while the government protects them. The honest are bamboozled by the distortion, and rush to validate it. The market, eventually, snaps back, and everyone suffers. . . EXCEPT those smart enough, or corrupt enough, to know it was coming and get out before the tsunami hits.

Consider that without regulation, there is no regulatory capture.

michael August 26, 2010 at 10:12 am

“Michael, I’m sorry but you’re simply wrong.

“The agencies I’m referring to are “Nationally Recognized Statistical Rating Organizations”, which are credit rating companies which have been given the SEC’s stamp of approval. this began in 1975..”

I can see your feet are set firmly into the turf, JG, and you are not to be persuaded. But the ratings agencies came first and the federal imprimatur came second. Plus, it came about through popular demand; investors, strange as it might seem to you, actually WANTED someone to keep an eye on the watchdogs.

You say that the SEC has been accrediting the ratings agencies since 1975? I note that Standard & Poor has been in operation providing investor information since 1860. So which is the chicken and which is the egg?

http://www2.standardandpoors.com/spf/html/media/SP_TimeLine_2006.html

“.. these are NOT a recent invention of bankers, they are a pure government construct.”

So first we have one straw man (I never suggested they were a recent invention of bankers) and one outright falsity (ratings agencies are demonstrably no government construct).

You are purveying disinformation. Don’t do it.

mpolzkill August 26, 2010 at 10:15 am

“WHY KEEP WEAVING NETS?”

Stupidity or nefariousness. No third option.

michael August 26, 2010 at 10:23 am

“In response to your last comment; ok, so “unscrupulous lenders” will find a way through “every net designed to snare them”?

“Then WHY KEEP WEAVING NETS?”

Ah, yes. The crooks are so wily, why should the cops even bother. It’s no use. Every game in town is fixed and there’s nothing we can do about it.

What side did you say you were working for? This sounds a lot like you actually WANT the game to be fixed. And don’t care about the resulting condition of the financial markets, once investors find there’s no way they can verify any of the information being offered them as sound and trustworthy.

In a condition of total opacity there would BE no markets. No one would trust anyone. They’d keep their cash under their beds, and never invest in anything they didn’t personally have a directorship in or control of.

For me the solution is obvious: keep mending our nets after every day spent on the water. Otherwise we’ll catch no fish.

mpolzkill August 26, 2010 at 10:36 am

http://www.youtube.com/watch?v=E_ATqDVIxqA

And with an awesome dissection of another related scam:

http://www.youtube.com/watch?v=8C4gRRk2i-M

JGiles August 26, 2010 at 10:36 am

Michael, please point out to me when i have said that the government does not do what the people want?

What many people want is to make life easier for themselves. Government does this. It does it by hurting everyone else.

I think you have the wrong idea about me. I am not saying that the government is some evil conspiracy out to crush our souls (though I know some people here do).

I’m saying that government attracts people who want control. They see something that seems bad; say, poor people can’t afford to buy a home. And they say, “Well, look, we can fix that. Just let us have this small amount of power, and we’ll fix this problem.”

And they do. They fix the problem entirely. And in doing so, they accomplish two other things; screw up something else beyond all recognition, and give the ruthless something to manipulate.

And the process continues, because there is always and forever another problem that the government could fix if us poor, ignorant free-marketers would just let it.

Now, about the specifics.

“The CRA was written into law back in 1977. And for a generation it worked as designed, failing to produce any outstanding crop of bad subprime loans. The loans originated under the act all performed about as well as comparable, non-CRA loans. Investors were not only happy, they were safe. The Community Investment Act was not at fault.”

You are missing a key word; “yet”. The CIA was not at fault “yet”. It was never a terribly good idea, but for quite a while it was a burden that could be borne.

“Then around 2002-04 unscrupulous lenders found and exploited loopholes no one had found before. And also, by then, CRA had undergone innumerable updates and alterations at the hands of the financial lobbyists who insert such amendments into any regulatory act that serves its purpose too well.”

Yes, exactly. It had been changed by, like it or not, THE GOVERNMENT. Because the government IS susceptible to such pressures from special interest groups! The market, by contrast, is not. One cannot lobby the market.

“But the ratings agencies came first and the federal imprimatur came second. Plus, it came about through popular demand; investors, strange as it might seem to you, actually WANTED someone to keep an eye on the watchdogs.”

Did I say that CRAs weren’t around until 1975? I don’t believe so; I believe that I said NRSROs weren’t around until 1975, which is obviously true. As long as none of the credit rating agencies were backed up by government muscle, they were fine. it’s once the government settles down behind a few of them that problems begin to arise.

I also never denied that investors wanted someone to keep an eye on the CRAs; I simply said that having the government do so, and particularly having it do so by allowing the use of certain agencies serve as an excuse for fraud, was a terrible idea. The proper organization to keep an eye on a company is, well, their competitors, who have a strong and vested interest in watching them like hawks.

Do you deny that the major NRSROs control practically the entire credit rating market? Or that they were wildly off-base in their ratings, so much so that it looks suspiciously like deliberate fraud? Perhaps you deny that the government gave certain organizations privileged status?

Stop making assumptions and actually read what I’m writing before you accuse me of “purveying disinformation”.

JGiles August 26, 2010 at 10:43 am

“What side did you say you were working for? This sounds a lot like you actually WANT the game to be fixed. And don’t care about the resulting condition of the financial markets, once investors find there’s no way they can verify any of the information being offered them as sound and trustworthy.

In a condition of total opacity there would BE no markets. No one would trust anyone. They’d keep their cash under their beds, and never invest in anything they didn’t personally have a directorship in or control of.”

Once again; you are not reading what I’m writing, and instead are responding to the fictional anarchist in your head.

The game is fixed BECAUSE of government. In a free market, how the hell do you fix it?

The way for an investor to find out if the information is trustworthy is to see what other people say about; like, the rating firm’s competitors, for instance. If one firm is crooked, the others will expose it in their own interest.

Why do you think there’d be “total opacity” in the absence of government regulation? People want to trade. Always have, always will. It’s in everyone’s interest, and pretty much everyone recognizes that. Is trade an issue of trust? Absolutely. And the free market, as I have said over and over and over, PROMOTES HONESTY. Because if you’re a liar, no-one will trade with you!

Government, on the other hand, promotes dishonesty, graft, and slipperiness. It’s the ones who can manipulate the government who get ahead, not the ones who actually do better.

michael August 27, 2010 at 8:22 am

“Michael, please point out to me when i have said that the government does not do what the people want? What many people want is to make life easier for themselves. Government does this. It does it by hurting everyone else.”

I see you feel aggrieved by the actions of our government, Mr Giles. In a democracy, the People (in principle) create the government they want. It, in turn, gives them the economic infrastructure that best promotes the general prosperity (or, as it is put in the Preface to our Constitution, “the general welfare”. Everyone’s happy. That is, everyone except “everyone else”.

Who exactly is this “everyone else”? And why are they so curiously unable to move beyond the grasp of this onerous government they must suffer?

Isn’t it a fact that they continue to live and conduct their operations here because they understand that this is the best place on earth to make a living? And that it is so precisely because the government we maintain must spend a lot of our money (much of it unwisely) in the maintenance of that system we find so beneficial to our fortunes?

I think you just don’t want to pay your desk rent. You want to use the office for free, and let someone else pay for the lights and the wiring, the nice address and the telex. Well, you know where the door is. We won’t insist that you stay here, using up resources we’re happy to pay for.

“I’m saying that government attracts people who want control. They see something that seems bad; say, poor people can’t afford to buy a home. And they say, “Well, look, we can fix that. Just let us have this small amount of power, and we’ll fix this problem.”

I see the urge to misattribute motive whenever someone proposes doing something to achieve social purposes. They CAN”T be just doing it to further the welfare of the public. Therefore they MUST be mere thirsters after raw power, malign creatures that want to distort our values. And make us encourage greater home ownership as a pathway toward middle class status.

In reality there are two sorts of people attracted to government work. Those who went through school and want a job in a nondramatic field tend to apply for a position in the civil service. And those who like excitement and fame go into politics, aspiring to become elected officials.

After this second group gets in, they find out the real nature of their work: fund raising. Any among them with idealistic principles find there’s precious little time left in the work week to think of glorious improvements upon our way of life. Instead they meet with lobbyists, to find out what needs to get accomplished in order for the money stream to flow.

The CRA was an exception, something Democrats did to court minority and inner city voters. And it worked fine for many years, until lobbyists inserted enough loopholes to drive a few trillion dollars through. You keep confusing “the government” with the powers that achieve their ends by exploiting flaws in the system. All those poor saps up in Congress are trying to do is to get re-elected. The crimes are committed by others who attach strings to their limbs and control them from above the stage.

“Did I say that CRAs weren’t around until 1975? I don’t believe so; I believe that I said NRSROs weren’t around until 1975, which is obviously true. As long as none of the credit rating agencies were backed up by government muscle, they were fine. it’s once the government settles down behind a few of them that problems begin to arise.”

Here I will forgive you. You are winging it. You obviously don’t know that the Community Reinvestment Act, or CRA, was passed by Congress back in 1978. Therefore no comment you can make on it makes sense. You might look it up on Wikipedia to gain the basic outlines. There are no “CRAs”.

Similarly, the several paragraphs that follow are wildly off base, and should be an embarrassment to you. You want to persist in making an untenable point, that the whole structure of the subprime debacle can be laid at the feet of “the government” because they somehow “gave certain organizations privileged status”.

Instead, the whole affair was motivated by lenders, who wanted to find a new way to make more money faster. And they jimmied with the inconvenient regulatory mechanisms until they were able to create a hole through which to pass a heap of fraudulent investments. Those in government who voted for those many amendments to CRA were certainly complicit, as they were in passing Gramm-Leach-Bliley. They were not the prime movers, however.

“Stop making assumptions and actually read what I’m writing before you accuse me of “purveying disinformation”.

I’m reading your every word very closely. And where I’ve been assuming you know you’re making false statements, it’s beginning to appear that you just don’t have a very broad factual basis. You should read more about the actual events in question. And not from your favored sources, who are in actuality the true disinformants. Read the more objective descriptions, the ones without value judgments.

JGiles August 27, 2010 at 8:29 am

Ok, I see our misunderstanding. I have been talking about CRAs the businesses, also known as Credit Rating Agencies, and only peripherally about CRA the law, the Community Reinvestment Act. I thought I had drawn a clear distinction between my points; perhaps I didn’t. In any case, please go back, read again, and try to understand what I was actually saying instead of dismissing it based on an incorrect interpretation of my acronyms.

michael August 27, 2010 at 8:44 am

This comment sheds light on the root distinction between our points of view, Mr Giles:

“The game is fixed BECAUSE of government. In a free market, how the hell do you fix it?”

In a free market the game stays broken. There’s no one to call on. If you want to subscribe to a ratings agency they can, and will, all be bought. That way they get paid twice: once by you to tell the truth and once by the issuers of the instruments they rate, to lie.

You come to this discussion as a philosopher, I’m thinking. For you, a logical conclusion MUST be agreed to by all, due to its compelling logic. But I come to the debate from a historian’s perspective. Humanity has never been logical or even straightforward. Our intelligence was built on the power to deceive.

Let’s take a look at how an actual free market operates. In ancient times the bakers cut the bread with sawdust. The grain sellers used loaded scales. The gamblers used loaded dice. And the pickpockets roamed the crowd. Sure, sometimes one got caught and the angry crowd tore them apart. But not so often that the cheap hustlers didn’t all think they could make a living on the strength of their wits there.

It was unsatisfactory. And that’s why the King became involved. He sent deputies into the marketplace with the express purpose of finding the cheats that so distorted the market’s activities. And when one was found he was promptly hanged, as an example to the others. It still wasn’t perfect– but it was better.

And there remained the serious problem that the deputies could be corrupted by any criminal successful enough to be able to bribe better than the King paid.

All you want to do is remove the deputies. That way things will be oh, so much better. Right? But it’s never worked out well when there’s been no competent regulation. In the absence of cops you always get more crimes, not fewer. This is so apparent to anyone with a brain you’ll have to forgive me for assuming you knew that. But I’m seeing that it’s news to you.

Phinn August 27, 2010 at 9:03 am

>>Let’s take a look at how an actual free market operates. In ancient times the bakers cut the bread with sawdust. The grain sellers used loaded scales. The gamblers used loaded dice. And the pickpockets roamed the crowd. Sure, sometimes one got caught and the angry crowd tore them apart. But not so often that the cheap hustlers didn’t all think they could make a living on the strength of their wits there. It was unsatisfactory. And that’s why the King became involved. He sent deputies into the marketplace with the express purpose of finding the cheats that so distorted the market’s activities.

This is not history. This is a parable. The Parable of the Cheating Merchants and the Selfless Deputies.

The Kid Salami August 27, 2010 at 9:11 am

And is this your idea of “historical” based analysis – anecdotal would be bad enough, but imaginary anecdotes pulled out of your ass? This is just too much.

“In ancient times the bakers cut the bread with sawdust. The grain sellers used loaded scales. The gamblers used loaded dice. And the pickpockets roamed the crowd. Sure, sometimes one got caught and the angry crowd tore them apart. But not so often that the cheap hustlers didn’t all think they could make a living on the strength of their wits there…..”

michael August 27, 2010 at 9:17 am

“Ok, I see our misunderstanding. I have been talking about CRAs the businesses, also known as Credit Rating Agencies, and only peripherally about CRA the law, the Community Reinvestment Act. I thought I had drawn a clear distinction between my points; perhaps I didn’t.”

Thank you, Mr Giles. Now we’re on the same page.

I think you’re complaining about the passage of the CRA (credit ratings agencies) Reform Act of 2006. Which says, in part:

“Congress finds that credit rating agencies are of national importance, in that, among other things—
(1) their ratings, publications, writings, analyses, and reports are furnished and distributed, and their contracts, subscription agreements, and other arrangements with clients are negotiated and performed, by the use of the mails and other means and instrumentalities of interstate commerce;
(2) their ratings, publications, writings, analyses, and reports customarily relate to the purchase and sale of securities traded on securities exchanges and in interstate over-thecounter markets, securities issued by companies engaged in business in interstate commerce, and securities issued by national banks and member banks of the Federal Reserve System;
(3) the foregoing transactions occur in such volume as substantially to affect interstate commerce, the securities markets, the national banking system, and the national economy;
(4) the oversight of such credit rating agencies serves the compelling interest of investor protection;
(5) the 2 largest credit rating agencies serve the vast majority of the market, and additional competition is in the public interest; and
(6) the Commission has indicated that it needs statutory authority to oversee the credit rating industry.”
http://www.sec.gov/divisions/marketreg/ratingagency/cra-reform-act-2006.pdf

My instinct is to feel that they framed this approach in response to a pre-existing condition of heightened investor risk, namely this:

“Until the early 1970s, bond credit ratings agencies were paid for their work by investors who wanted impartial information on the credit worthiness of securities issuers and their particular offerings. Starting in the early 1970s, the “Big Three” ratings agencies (S&P, Moody’s, and Fitch) began to receive payment for their work by the securities issuers for whom they issue those ratings, which has led to charges that these ratings agencies can no longer always be impartial when issuing ratings for those securities issuers.” (from Wikipedia again)

The SEC had this to say about the necessity of bringing CRAs within the reach of regulation:

“The Securities and Exchange Commission (“Commission”) recently adopted new rules relating to the oversight of nationally recognized statistical rating organizations (“NRSROs”). The rules were in response to the requirements of the Credit Rating Agency Reform Act of 2006 (“Rating Agency Act”) and were enacted to improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry. The Rating Agency Act requires a credit rating agency seeking to be treated as an NRSRO to apply for registration with the Commission, to make public certain information to help persons assess its creditability, and to implement procedures to manage the handling of material nonpublic information and conflicts of interest.”
http://www.sec.gov/divisions/marketreg/tmcompliance/nrsro-secg.htm

So we would want to then go back to the early 1970s to see what it was that had changed to bring about the need for an increased oversight of what previously had been a well-ordered marketplace (one where the ratings agencies were paid directly by the investors, and any attempt at payment on the part of the firms being rated would be seen as bribery and inducement to fraud). Would you agree that this was a reasonable assumption?

To me, it would fit a pattern of the perps finding a new way to commit fraud, and the regulators having to pass a new law to bring it under control. If we put the timing of the Act into focus, it would have been at the moment of realization that such bad actors as Worldcom and Enron had hornswoggled the public by, among other things, flying under the cover of AAA ratings. Public outrage would have demanded a regulatory response. Too many people had lost their life’s savings.

But even this first step at bringing false ratings under control was no silver bullet. The problem continued:

“In August 2007, the SEC staff initiated in-depth examinations of the three major rating agencies and over a 10 month investigation uncovered significant deficiencies in the rating agencies’ policies, procedures and practices.
The examinations found that:
• The CRAs struggled significantly with the increase in the number and complexity of
subprime RMBS and CDO deals since 2002;
• None of the CRAs examined had specific, comprehensive, written procedures for
rating RMBS and CDOs;
• Significant aspects of the rating process were not disclosed or even documented by
the firms;
• Conflicts of interest were not always managed appropriately; and
• Processes for monitoring ratings were less robust than the processes used for initial
ratings.
http://www.imf.org/external/pubs/ft/wp/2009/wp09129.pdf

It look s to me very much like the government’s motives were not to issue licenses to steal, but to prevent those abuses that were during this period all too demonstrable.

Perhaps I’m overly cynical, but when I put together your obvious familiarity with the issue and your vehement condemnation of regulatory efforts, I am tempted to conclude that you’re uncomfortable with the government’s attempts to bring these obvious abuses under control. Would you, by any chance, be in the business of creating and issuing derivatives, credit default obligations and the like?

(We’ll have to get back to the events of the early 1970s later. I am intrigued by what we’ve discovered so far, and will be inquiring into the cracks and crevices that had been created before responding further.)

mpolzkill August 27, 2010 at 9:18 am

From pickpockets being torn to ribbons to Bernie Madoff suffering a couple shoves on the way from his Park Avenue penthouse to the minimum-security prison. Michael *has* made a good case as to why life is better for his class today.

michael August 27, 2010 at 9:39 am

Phinn and Salami: The abuses I cite in the medieval marketplace are neither parables nor imaginary anecdotes I pulled out of my fundament. Those are all historical realities, as described by chroniclers from London to Baghdad.

Are you trying to peddle the notion that unmanaged markets in the premodern world had no thieves or cheats? And that this sublime condition arose from a lack of sheriffs’ deputies to enforce the King’s writ?

Here are some other common practises during that period: coin clipping; adulteration of wine; purse cutting; forgery and counterfeiting; the use of baskets with false bottoms; the sale of lame or infirm horses; the passing of base metal as silver or gold; the use of ‘Mickey Finns’ to drug the unwary for robbery; the sale of false remedies, supposed relics and magical potions; and many more. In a word, the kind of things you find in any uncontrolled marketplace.

There was a great hue and cry to rid the markets of such cheats, and make them safe for what were termed ‘honest sellers’. The laws were created by popular demand, not just because the King wanted something to do. People found that markets didn’t work well without both good rules and honest enforcers.

(I am indebted to A. McCall’s excellent book The Medieval Underworld for these details.)

mpolzkill August 27, 2010 at 9:49 am

1 When Samuel grew old, he appointed his sons as judges for Israel. 2 The name of his firstborn was Joel and the name of his second was Abijah, and they served at Beersheba. 3 But his sons did not walk in his ways. They turned aside after dishonest gain and accepted bribes and perverted justice.

4 So all the elders of Israel gathered together and came to Samuel at Ramah. 5 They said to him, “You are old, and your sons do not walk in your ways; now appoint a king to lead us, such as all the other nations have.”

6 But when they said, “Give us a king to lead us,” this displeased Samuel; so he prayed to the LORD. 7 And the LORD told him: “Listen to all that the people are saying to you; it is not you they have rejected, but they have rejected me as their king. 8 As they have done from the day I brought them up out of Egypt until this day, forsaking me and serving other gods, so they are doing to you. 9 Now listen to them; but warn them solemnly and let them know what the king who will reign over them will do.”

10 Samuel told all the words of the LORD to the people who were asking him for a king. 11 He said, “This is what the king who will reign over you will do: He will take your sons and make them serve with his chariots and horses, and they will run in front of his chariots. 12 Some he will assign to be commanders of thousands and commanders of fifties, and others to plow his ground and reap his harvest, and still others to make weapons of war and equipment for his chariots. 13 He will take your daughters to be perfumers and cooks and bakers. 14 He will take the best of your fields and vineyards and olive groves and give them to his attendants. 15 He will take a tenth of your grain and of your vintage and give it to his officials and attendants. 16 Your menservants and maidservants and the best of your cattle and donkeys he will take for his own use. 17 He will take a tenth of your flocks, and you yourselves will become his slaves. 18 When that day comes, you will cry out for relief from the king you have chosen, and the LORD will not answer you in that day.”

19 But the people refused to listen to Samuel. “No!” they said. “We want a king over us. 20 Then we will be like all the other nations, with a king to lead us and to go out before us and fight our battles.”

21 When Samuel heard all that the people said, he repeated it before the LORD. 22 The LORD answered, “Listen to them and give them a king.”

Then Samuel said to the men of Israel, “Everyone go back to his town.”

- First Samuel, chapter 8

The Kid Salami August 27, 2010 at 11:19 am

Ok, perhaps I wasn’t clear. It was really this comment that galls me at the end of your anecdote – “It was unsatisfactory”. This is just dropped in but really it is a gigantic leap.

“In ancient times the bakers cut the bread with sawdust.”

People can shop at another bakery who will, eventually, take the custom of those who use sawdust.

“The grain sellers used loaded scales.”

Ditto – another grain seller.

“The gamblers used loaded dice.”

Odds too low? Stop gambling or go to another casino, one who’ll see their dissatisfaction and set-up accordingly to get their custom.

“And the pickpockets roamed the crowd.”

Sew buttons on your pockets or hold your valuable or whatever.

All perfectly reasonable. Yet your solution is “let’s give the guy with the most power even more so he can end this – and, I promise, there’ll be no side effects to this at all”? None of these require more power to the state to sort out – so do you have any other more relevant anecdotes?

Scott D August 27, 2010 at 12:05 pm

michael:

“In ancient times the bakers cut the bread with sawdust.”

Your implication is that this was widespread, or at least, widespread enough to merit the attention of the king. My own research indicates that this was unlikely. To get any appreciable savings, the amount of sawdust needed would create an unrisen, inedible lump. People did resort to eating undigestibles like sawdust and tree bark in times of famine, and in these times, the bakers would make a convenient scapegoat when the people began to grumble to their lords about the lack of food.

“The grain sellers used loaded scales.”

And got away with it everywhere, every time, I expect. After all, we only hear about it when someone gets caught, and honesty is never in the interest of the seller, in michael’s Land of Evil Merchants.

“The gamblers used loaded dice.”

Dice being a primary factor in trade. (nod)

“And the pickpockets roamed the crowd.”

Because crime is a sure sign of a healthy, unhampered market in michael’s world. People resort to crime when they lack the ability to provide for themselves in a safer, more honest manner–or when the incentives are very high relative to risk.

“It was unsatisfactory. And that’s why the King became involved. He sent deputies into the marketplace with the express purpose of finding the cheats that so distorted the market’s activities. And when one was found he was promptly hanged, as an example to the others. It still wasn’t perfect– but it was better.”

Your use of terms here is innacurate. “Distorted the market’s activities”? Fraud and theft are not market distortions. To have a distortion, you have to have incentives, disincentives, or restrictions imposed on economic activity. Thieves and shysters might result in goods, services and money being moved without the informed consent of actors in the market, but they do not represent distortions. They exist in spite of the market, not because of it. Indeed, hamper the market and/or experience a famine and these activities quickly increase out of control.

“And there remained the serious problem that the deputies could be corrupted by any criminal successful enough to be able to bribe better than the King paid. All you want to do is remove the deputies.”

It’s a bird! It’s a plane! Ah crap, nevermind, it’s just a strawman argument.

You are conflating law enforcement with regulation. Opinions vary widely among libertarians about the proper disposition and dispensation of law enforcement. Some claim we need a minarchy to provide police protection, while others believe it can all be handled by private firms. What most of us can agree upon, I think, is that it is not the government’s business to decide, say, the maximum fees that a bank can charge when one of its customers goes over limit, or set a price floor on wages, or to defend the public from unscrupulous florists and hairstylists who would operate without a license. Regulation seeks to restrict voluntary activities, not to punish thieves and murderers.

“That way things will be oh, so much better. Right? But it’s never worked out well when there’s been no competent regulation.”

Okay, I’ll buy that. Now we just need some of this mythical competent regulation.

“In the absence of cops you always get more crimes, not fewer. This is so apparent to anyone with a brain you’ll have to forgive me for assuming you knew that. But I’m seeing that it’s news to you.”

Again, more regulations = more/better law enforcement?

By the way, what’s your opinion on the War on Drugs, there, Mike?

michael August 27, 2010 at 1:45 pm

Thank you for your observations, Salami and Scott. It does happen to be historical fact that popular outcries led to marketplace controls in the Middle Ages. Because the markets didn’t really work well without them. You’ve heard the saying that bad money drives out the good? It’s the same with sharp practises. They drive out the good, so what you are ultimately left with is merchants who all have to cheat to survive.

Criticise this historical fact all you like. You’ve still yet to offer any compelling reason why markets will just magically work perfectly once we stop policing them. The idea is utter craziness, fortified with no evidence.

With no way of knowing who is lying, prospective customers will just distrust all wares, and end up dealing only with those they know personally and trust. Global trade will reduce itself back to the village level. Warranties will be worthless. And there will be no credit markets, with an absolute certainty. You won’t even be able to hire a trucker to tote your turnips to market; he’ll just likely drive off with them and disappear.

We invented government and the law for perfectly good reasons. And if you have to repeat the experiment before you begin to understand those reasons, at least go off somewhere far from here to do it.

Scott, you put a fresh wrinkle on the argument here:

“You are conflating law enforcement with regulation. Opinions vary widely among libertarians about the proper disposition and dispensation of law enforcement. Some claim we need a minarchy to provide police protection, while others believe it can all be handled by private firms.”

Kenya and Ecuador are two places where you’re very much better off buying private security. But it’s more expensive and more confining than living in a relatively safe country. You need to hire dogs and a dog handler to protect your premises– plus an alarm service. You need a driver (unless you’ve taken the antiterror driving course, and feel confident you can foil kidnapping attempts). You need a shopper to go downtown for you (you can’t go into crowds yourself). And you’ll want one armed and trained expert to be with you at all times, for personal security.

The reason all this is so is because those governments are weak. Yes, they do have layers of municipal police, state and federal police, federal militias and of course the army and national security services. But if you interact with those folks in any way they’re going to want you to pay them.

I like it here. Pay your federal, state and local taxes and you get it all taken care of with no additional billing or tips needed. It’s a package deal.

michael August 27, 2010 at 2:10 pm

“By the way, what’s your opinion on the War on Drugs, there, Mike?”

Why Scott, what a question to ask!

The War serves many purposes.

1. It’s politically useful. Politicians get elected when they make war on whatever people fear: drugs, terrorists, Red Commies, ‘illegal’ aliens, exotic religions, odd sexual habits or people not like us in some way. Making war on something like drugs earns votes.

2. It’s an easy way to divert the public’s attention from the more important things that are happening to us, things that don’t make the news.

3. It serves as a convenient cover for us to insert ourselves militarily in third world hellholes that only have drugs for a cash crop. It also provides a handy conduit for the CIA’s funding via drug sales. With the one hand we can interdict the competition, while with the other we can still provide America’s drug using youth with their product of choice. It’s a source of off-budget funding.

4. It’s a game. People with cop mentalities like being above the law, and playing big boys’ games.

There are probably more reasons why we make war on drugs. But political expediency, fun for cops and large sums of money are probably the big ones.

michael August 29, 2010 at 11:29 am

JGiles: There’s a lot in your comment that cries out for some clarification from a real estate perspective.

1. “The banking sector was not only allowed, not only encouraged, but actually MANDATED by, yes, the government, to make subprime loans. In short, they were forced by their Federal overseers to take losses. Then some bright banker somewhere thought up the mortgage-backed security, and look! The government didn’t mind THAT at all! So the banking sector made terrible loans to the poor, making the government happy, and then bundled and sold them for billions of dollars, making their shareholders happy.”

No interpretation of the CRA ever required any bank to make any unsound loan. If a bank were to remain within the law, all they would have to do would be to process a certain number of loan applications within an identified low-opportunity neighborhood. If they could then demonstrate that few of those applications were acceptable under prudent qualification practises, they were home free. They were not forced to accept bad customers, only to consider anyone who came in the door and not reject them for unsound reasons.

I can’t emphasize this enough. Prudent banks opened their doors to subprime customers. And if they failed to qualify, they just failed to qualify. Those banks WERE NOT prosecuted and they DID NOT lose any money on bad loans. All they did was to restrict themselves to customers would could afford to service the loans they secured.

2. “Everyone was happy. . . well, except for those people in homes they couldn’t afford, struggling to make payments. And those people foreclosed on, who couldn’t find a place to live because real estate was so expensive now. And those people trying to make a living honestly in banking, watching their dishonest competitors rewarded with massive profits while government regulators forced the honest bankers to take loss after loss on subprime loans.”

Not so. Fiscally conservative banks have always, at least up until this latest mess, outperformed the high rollers. During the last major real estate downturn prior to this, Washington’s tiny family-owned bank, National Capital Bank, earned an award for losing less money than any other local lender in DC. Their feat of brilliance? Not to lend at the ragged edge, but to insist on qualified applicants and to hold the loans they originated.

3. “Did the government “make” people stupid? Not at all. But whatever its intentions were, the government DID create an environment which rewarded thievery and discouraged sound banking practice.”

You forget that all the deregulatory legislation that’s been passed over the past thirty years has been at the behest of the financial sector. They are, by a considerable margin, the largest lobby in Washington. So when you blame the regs, you blame the banks that wrote them. The Community Reinvestment Act, most specifically, was altered numerous times, so as to increase the opportunity for profitable abuse.

The banks got thrown into the subprime situation like Br’er Rabbit got thrown into the briar patch.

Matthew Swaringen August 29, 2010 at 12:47 pm

But who bailed them out michael? It certainly cannot be blamed on those of us who are against our money being stolen and handed to the very criminals you bring up now.

No one here is claiming that the financial executives are angels. Quite the contrary, the whole problem in every sector in which government involves itself is huge amounts of crony capitalism. This is the nature of the beast. You act as if the government is the angels here, only trying to make things better for us all. Such a thing is nice except that I know you know better. You know what government is just as well as any one of us here.

It’s nothing more than a monopoly on the use of force. It’s no better than the mafia, and the fact it’s democratic provides it no further legitimacy given, as you admit, it’s constant play to separate special interest groups. In fact, democracy provides this very necessity.

JGiles August 27, 2010 at 9:48 am

No, I do not and never have worked in any aspect of the banking industry. In point of fact, I work for the government!

And no, I am not complaining about the 2006 Act. I am referring to the practice of the SEC, going back to 1975, of designating a certain subset of CRAs as NRSROs, Nationally Recognized Statistical Rating Organizations. I have several problems with this.

1. It was a governmental vote of no confidence in the intelligence of investors. As I’ve said repeatedly, in a truly free market the smart investors thrive and the stupid ones generally lose. Market participants, left to themselves, would handle their affairs competently, because those who do not quickly find they have no affairs to manage.

2. It was an assertion that it is the place of the government to save people from their own foolishness. This is emphatically not true. If I wish to trust a certain company, despite public knowledge that their ratings are bought and paid for, why should everyone else in the country be on the hook to prevent me from following my lemming-like self-destructive impulses?

3. It was based on the presumption that the government knows what people want better than those people themselves do, which is, once again, false. If I want an honest credit rating, I will demand one, and I won’t buy dishonest ones. If enough people do that, the dishonest companies go out of business while new, honest companies spring up to serve the changed demand. Will this happen immediately? No. But it will happen. And the government cannot replace this market ability once it has supplanted it.

4. It created a financial aristocracy, by giving those who used NRSROs special privileges. Those financial institutions using NRSRO ratings were allowed to ignore certain capital requirements, which I would argue both contributed to the recent financial collapse and gave NRSROs an enormous competitive advantage over their less-blessed competitors. Basically, it amounted to government permission to commit fraud if you dealt with a certain “trustworthy” subset of CRAs.

5. Finally, it is evident that all the SECs attempts to make the market “safer” were totally ineffective, and may actually have materially contributed to the collapse by encouraging investors to rely on a few, hopelessly corrupt companies for credit ratings.

michael August 27, 2010 at 1:57 pm

JG: Let’s imagine a world where there’s no regulation. Markets are self-policing. And anyone wanting to float a bond issue is left on his honor to pay back the money.

Bond ratings agencies will arise to tell you an individual’s track record. But that just means they only get to scam you once. Then they dissolve, and show up elsewhere under another name to scam other people.

And if a company decides they can just lie brazenly in offering their financials for your perusal, what makes you think they will be above bribing the agency that rates them for you?

You’ll be in a venue where everyone is lying. And in such places people don’t let others handle their money… ever. There’ll be no such thing as banks or credit. Because those things are based on trust. You tell me “in a truly free market the smart investors thrive and the stupid ones generally lose”. But everyone here agrees that we’ve never seen a truly free market. So you have no evidence of this, only a presumption based on ideology. The smartest investors will quickly conclude that every game in town is either potentially or actually rigged. And he won’t invest.

Government certification hasn’t prevented gross abuses. But you would be very far off base to believe that an absence of certification would result in any improvement. I have offer the real reason the CRAs fell down on the job twice now, and you haven’t acknowledged it. They used to be paid by the investors, and they came to be paid by the very securities they graded. The regulations preventing such a thing from happening were relaxed.

How would this be different in your ideal world?

Peter Surda August 27, 2010 at 2:04 pm

Michael, some people don’t give huge amounts of money to strangers who have no references. Imagine that.

mr taco August 27, 2010 at 2:07 pm

so michael how come regulation couldnt stop bernie madoff even despite a whistle blower(forgot his name) warned them

michael August 27, 2010 at 2:14 pm

Our government has become corrupted. The SEC, the EPA, the FDA, the Coast Guard and any other number of agencies serve as arms of the very industries they are supposed to protect against.

The Madoff case was particularly blatant. There’s no excuse. Yet no one will ever be punished for such things.

Explain to us again how such things as Bernie Madoff’s Ponzi could never ever happen in a society free from controls.

Matthew Swaringen August 29, 2010 at 12:37 pm

“Our government has become corrupted. The SEC, the EPA, the FDA, the Coast Guard and any other number of agencies serve as arms of the very industries they are supposed to protect against.”
The only problem I have with this statement is the word “become.” It has always been corrupt because it has always been government, and thus always been a place for the use of institutionalized violence. The fact that violence is used primarily for the powerful should be no surprise to anyone.

“Explain to us again how such things as Bernie Madoff’s Ponzi could never ever happen in a society free from controls.” —> meet <—- "Michael, some people don’t give huge amounts of money to strangers who have no references. Imagine that."

Victims of this sort also would have every right in a free market arbitration system via Dispute Resolution Organizations to challenge Madoff type individuals on not doing what they claimed (fraudulent activity). It is not that society would be "free from control" insofar as you mean laws governing that which everyone would agree is wrong.

It is that we would not have regulations against things enforced by a monopoly on force, which makes regulations in hindsight without any foresight to know the ramifications of those regulations. (They don't know if they can enforce the regulations that they write, they don't seem to know if those regulations won't cause or encourage other problems, etc.)

I would never say that a Madoff type situation can't occur in any society. But that's not the point of a society at all. People should never be discouraged from looking out for themselves through the belief that an all knowing, all seeing government is looking out for them and will set things right. It didn't. All government did in the end for the Madoff situation was put the guy in jail. In my world, who would pay for such a thing? Madoff would likely be working with literally all his income going towards those he hurt. Would it ever amount to the amount lost? No, it probably would not. But freedom to fail because you did the wrong thing and choose the wrong person to give money to, not diversifying at all… or researching at all is not a bad thing.

Even if those people do not learn, others will learn from them what they should not do.

It's also worth saying that the reason people have to invest speculatively has a lot to do with the Federal Reserve inflation system you support. If they didn't lose ~3% or more of the value of the dollar annually (~50% of it's value every 23 years), it might be possible to just save a portion of their income without investing at all to cover their retirement. Then people like Madoff would have a lot less reasons to get the money from these people.

michael August 29, 2010 at 3:59 pm

Matthew, you paint the picture of some Luddite paradise, where there are no banks and no speculative investments– because no one would have any reason to trust anyone else’s representations.

Your “dispute resolution organizations” would have no effect if they didn’t have enforcement. And I assume you are against all forms of enforcement because that would constitute coercion. So if adherence to the decisions of the DRO were voluntary, any Bernie Madoffs in the system will have figured out beforehand that their responsibility for their investors’ money would also be voluntary.

There would be a permanent predominance of Madoffs in the market– to the point where the market would disintegrate. Everyone would “look out for himself” by never giving anyone else any of his money for any reason. But that’s all right with you, because in a world without inflation, no one would ever need to invest. So our mutual universal distrust of one another would make any thought of investment moot.

Such a simple world. Money would be kept in one’s cabinet, well locked. And whenever one took his money bag out, a pound of potatos would cost as many grains of gold as it did last year. It all sounds lovely.

Thinker August 29, 2010 at 4:59 pm

michael,

There are two possible ways to regulate any market, financial or otherwise: government supervision or private rating. While neither produces a “perfect” outcome in the sense of preventing all fraud and allowing optimal growth, the government option paradoxically both over-regulates and under-regulates.

Suppose there exists a government that does not regulate markets. One day, it decides to lay down rules for some market. The government claims a monopoly of rule-making and enforcing (note: this goes hand-in-hand with the government’s monopoly of arbitration in general). In this situation, anyone may make whatever contracts they wish, so long as their contract is within the state-imposed bounds. This monopoly framework means that the government will tend to expand regulation over time. At the same time, there will be incentive for the government regulators to be lazy and inattentive, as they do not depend on the quality of their services for their compensation. Thus, the government will tend to over-regulate where consumers want less regulation and under-regulate where consumers want more regulation, and it will have no way of rationally improving its regulatory structure because it lacks the profit/loss feedback mechanism. Even in those cases when it gets its regulations “right,” it will not be able to determine what it is doing that consumers actually want.

Now to examine the private alternative, suppose again that there is no government regulation of markets. Also suppose that if there is a government its arbitration services are usually just, or if there is no government that private competing arbitration agencies provide services to the same effect, so as to eliminate the most basic problems of fraud. Problems of asymmetric information still remain, however. We’ll start at the very simplest level–I have a friend named Bob. I know Bob well and believe that he is an honest and fairly wise man. If I have some savings, and Bob has need of capital to expand his business, I would probably be willing to lend my savings to him without much fuss because I trust that he will return my money to me. However, if there is someone else in town, say named Bernie, who I don’t know as well, I will ask people I know, or perhaps people I don’t know personally but who have a good reputation, about Bernie and whether or not it is a good idea to lend to him. Depending on the assessments people give him, I will decide whether or not to lend to him and if so, at what rate. For more developed markets, this assessment function is taken over by competing rating firms with their own rating scales. Consumers will select which rating schemes are of most interest and value to them, so firms that provide the kind of “regulation” that consumers actually desire will tend to predominate, while firms that “regulate” contrary to consumers’ demands will tend to go out of business.

Of course, in the private system, securities firms and rating firms could connive to defraud the consumer, but so may securities firms and a government agency, and the private firms must keep their collusion secret in order to continue to operate. If a private rating agency is known to be in cahoots with securities firms, it will tend to suffer substantial losses, possibly going out of business. By contrast, a government agency in cahoots with securities firms may suffer a major scandal, but it will not actually suffer any losses from its nefarious actions, so it will be more inclined to engage in this kind of collaboration.

Jeffrey Tucker August 24, 2010 at 4:42 pm

Yikes! prices are behaving in a rather funny way

http://money.cnn.com/2010/08/24/news/bacon_prices/index.htm

Bruce Koerber August 24, 2010 at 6:09 pm

Ups And Downs Caused By Economic Quackery.

Wall Street Journal reports the ‘gravity’ of the situation. Being a major cog in the economic machinery of the Keynesian quacks, the housing plummet is sure to alarm them about the ‘gravity’ of the situation. Will it go thunk or ricochet ping-ping-ping down deeper and deeper into a crevasse?

Meanwhile bacon sizzles and pops. Is the volatility good news?

It sounds like the ego-driven interventionists have put us between a rock and a frying pan.

Dave August 24, 2010 at 8:07 pm

The number one cause of the housing boom/bust was artificialy low interest rates. You remove that from the scene and it would be impossible to happen.

Jon Leckie August 25, 2010 at 1:56 am

Sorry michael, but I’ve got to give Dave the prize for best in class. It wasn’t the discount window, but the existence of a central bank able to interfere with the market price of capital and set the price below the market rate, flooding the market with liquidity. It is the market that should coordinate time with interest, not a functionary of the state. With capital priced so low, the market (constituted by the millions and millions of private individuals and corporate entities) was sent false signals as to the level of savings available for investment. The resulting malinvestment – centred mainly in private housing this time, last time it was dotcom stocks, Florida property, tulips, it really can be anything or several anythings – boomed and then busted. Blaming the banks and mortgage originators is frankly stupid. Why?

Here’s why. Capitalism – being the economic expression of Liberalism – works because it harnesses the self-interest of each individual in the community. Price signals represent the amalgamation of millions of separately held bits of information that together signal very effectively the end to which a particular resource can be most profitably applied. Private actors respond to price signals and if the government intervenes, capital allocation is distorted. Where the price of capital is interfered with, you get crazy distortions indeed. Decisions are made based on a government provided falsehood: That there is such a glut of savings available that anything over a couple of percentage points’ return on captial will generate a profit. It’s all a fantasy, a smokescreen, a house of cards. And the answer – at least to me – cannot possibly be more government regulation, more interference, more distortion to correct the previous distortions. You have to clean out the distortions and let the price mechanism allocate resources again. Hence I arrived at my current world view.

I hope that’s enlightening or at least clear and maybe a little bit interesting.

michael August 25, 2010 at 6:53 am

“I hope that’s enlightening or at least clear and maybe a little bit interesting.”

All of the above, Jon. I would agree that that has plenty to do with it. The tone of the money market was undoubtedly set by those Fed policies. But I don’t think they occurred in a vacuum. When you look at all the insane profits that have been booked over the past thirty years I don’t think you can deny there was plenty of cash floating around out there, looking to get itself placed. You could just as easily say that the Fed was acknowledging a reality, that the financial world was awash in a sea of loose money. It was the cheapest, most abundant commodity on earth.

What you’re trying to convince me of is that absent that additional Fed-bred liquidity, the market would have behaved differently. Maybe so, we’ll never know. The loan rates would have been a couple of points higher, and that would have kept down the worst of the excesses in appreciation. But we’d still have had a bubble.

The instance I look to for guidance is the bubble that developed in the late 1970s. Interest rates for home borrowers were in the 8-9% range, creeping toward ten… certainly not low by anyone’s standards. Yet prices doubled and nearly doubled again in a short handful of years. Then when Volcker’s tight money policies sent rates through the roof (I would consider 13-14% as being “through the roof”) the back of the housing market had been broken. People who had bought in at $300K found the following year that they couldn’t sell above $240K. Suddenly the cities were awash in unsalable houses, and the unsold flotsam then swamped the rental market.

Note: I don’t blame Paul Volcker for any of this. He did what he had to do, inject some sanity into an untenable situation. But their were howls of pain aplenty. (I also note that those unprecedented interest rates might have wrecked the RE market, but they were only barely ahead of the current rate of general inflation.)

It was an unsustainable market. And even with moderately tight money policies in 2004-07 (which in retrospect would have been a good idea) we’d still have seen a pop-and-crash, just from the pressure of so much real capital looking for a place to play and encouraging brokers to sin. IMO, naturally– but I’ve been watching it pretty closely.

Daniel August 25, 2010 at 11:51 am

It really irks me when anyone talks about a market being “stable” since it underlies premises so stupid and contradictory, it is a wonder these two words get spoken in the same sentence.

Now, the why:
1. References to a “stable market” usually imply that it is a necessity and man must take action to make said market stable. This is absurd because it is a claim that man is the one that serves the market, and not the market that serves man.
2. In the same vein as above, since the market serves man, the market is a means to an end, the end being “fulfilling man’s desires” (I don’t mean this in a marxist way where priviledges are called “rights” but in a Misesean way). And since man’s desires are inherently unstable, a “stable” market, thus, would not be suitable to fulfill these desires.

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