Tuesday, March 02, 2010

Stiglitz's Freefall

The subtitle should be "why free market types are like religious fundamentalists", because he loves using the cute phrase 'market fundamentalism' the way MSNBC uses the phrase 'tea baggers'.

A nice thing about being a Nobel prize winner in economics is when you write books with the same policy recommendations, but use inconsistent arguments in each book, you still get the front table at Barnes and Noble. FreeFall makes the standard talking points you hear on AirAmerica, MoveOn.org, or Noam Chomsky:

1) every economy needs more regulation and higher taxes, especially on the rich
2) He, along with everyone who agrees with him that markets are irrational, predicted the 2008 financial crisis
3) the Community Reinvestment Act and similar government programs had absolutely nothing to do with the crisis.
4) the bubble was fueled by Greenspan's easy money from 2002-2007.

Why do we need more taxes and regulation? Well, according to Stiglitz, the rich are generally immune to incentives, probably parasitic, and generally monopolistic. Like Russian Kulaks, Jews in pre-War Germany, Indians in Uganda, the rich are impediments to growth & justice. Yet he also notes a large amount of financial innovation is to skirt taxes and regulations. I agree that many finacial innovations are focused on taxes and regulations, but that's only because these exogenous rules tend to create mutual gains from trade, and so are bad only if you think prices are wrong (ie, market participants are predictably wrong, or fail to capture externalities).

His proof that the CRA and other government housing initiative had nothing at all to do with the housing bubble, is proven thusly: AIG failed, and they didn't issue mortgages, just bought bonds and derivatives. QED. Further, subprime mortgages failed at rates similar to CRA related subprime mortgages. Yet, current law does not allow a bank to charge different prices based on race. To increase the amount of loans in historically underserved demographics--poor people--you have to lower the bar for all loans.

The old and seemingly irrational rules of thumb of having certain levels of wealth, credit score, validation of income, and downpayment, were diminished because of the fact that banks historically had low losses on mortgages, because there was little evidence of large year-over-year aggregate declines in real housing prices. Thus, for example, we went from requiring 20% down in the 1990's, to zero percent down in the bubble (now upped to 3.5% by the US's FHA). Indeed, Stiglitz himself wrote a white paper arguing that Fannie Mae's 2% capital requirement was more than adequate in 2002 (he estimated an expected loss on $1 Trillion by Fannie of only $2 Million--pre hindsight). Indeed, Fannie Mae was one of his examples of beneficial government policy in his 2002 book The Roaring Nineties. Fannie and Freddie have already cost the government $127B, and it's not done. That's 90 Nick Leesons and counting, but the nice thing about being an intellectual is you aren't accountable for for how policies that were aided and abbetted by your arguments actually worked, because if it fails, it wasn't implemented correctly (eg, Socialism didn't fail, rather, Soviet-style socialism failed).

His assertion that he called the subprime crisis is pretty weak. Look in vain for any strong statement by Stiglitz that underwriting for home lending was too easy prior to 2007, and you won't find it. He did reference an argument he made in 1992 that mortgage asset backed securities may be problematic, but this was a hedged statement, and not important enough to reassert over the subsequent 15 years.

In Stiglitz's Globalization and Its Discontents, written in 2002 just after the internet bubble, the big policy blunders where high interest rates, free markets, the 'fear of default' by lenders, and a lack of concern for the poor. He specifically mentions that Greenspan was excessively concerned with inflation during the 1990's, constraining the Clinton's ability to create economic growth. So, the easy money, lack of concern with default, and insufficient initiatives targeted to the poor, all arguments that he now asserts caused the 2008 crash, would seem to be right out of his playbook. Consistency is for non-experts, I guess.

In his 2006 book, Making Globalization Work, Stiglitz praises Japan, Korea, and China, for their high-minded government policies and trade restrictions as an impetus for growth. Now, modern economies all have government of at least 25% of the economy, and many regulations on businesses. Any success could be a result of some governmental interference, which are many. But to be convincing, one would have to do a true cross-country comparison, and like typical theorist his idea of data is anecdote. The Asian Tigers, West Germany's Adenauer, Chile, recent ascent of Ireland are all ignored. As is the fact that China and India moved considerably towards free markets at the same time their growth rate rose, or that Japan and Korea are less regulated than most nations.

Stiglitz's two most prominent papers are papers he coauthored: "Credit Rationing in Markets with Imperfect Information", The American Economic Review (1981), and his “On the Impossibility of Informationally Efficient. Markets”, American Economic Review (1980). He has always been a theorist, not an empiricist.

Grossman and Stiglitz's "On the Impossibility of Informationally Efficient Markets" flows naturally from Grossman's work on getting information into prices, and Stiglitz's obsession with market imperfection (which came from his fawning work on Samuelson's collected works, which tended to emphasize market imperfections). I have never seen an empirical application of this paper. It's often used as a profound proof that markets aren't efficient, for those who think the relevant standard is perfection. If all information is totally transparent, symmetric, and logical, nobody trades securities with anyone, like what Stokey and Milgrom proved in their No-Trade Theorem (1982, Information, Trade and Common Knowledge, Journal of Economic Theory).

What really bothers me about the paper is its pretentiousness, as if they proved something profound. They proved something obvious. Sure the proof is hard (you solve a differential equation and there's a chi-squared distribution), but the results aren't surprising to anyone. A really neat theory should be important (in this case: maybe), succinct proof (no), and slightly surprising(not!). G&S have all these results in the paper that are really obvious, like the greater the noise, the less informative the price system will be, or the lower the utility of the uninformed, etc. Stigler and Hayek basically argued the same idea, that all the theoretical papers that assume 'perfect competition' and perfect foresight basically assume no need for the market: the data sufficient for a central planner is assumed available. Yet, economies need entrepreneurs and businessmen seizing profits precisely because relevant information is parochial and flawed. Decentralized decision-making takes advantage of decentralized information, and profits are the incentive. So, his demonstration the market perfection is never, technically, true, isn't a critique of the market, it's why many free marketers believe what they do.

In their seminal paper on credit rationing, Stiglitz and Weiss (1981) posed the question: “Why is credit rationed?”. In a perfect capital market with all information available to everyone banks give risk adjusted credits to borrowers of different types. Banks choose in a perfect competition the interest rate such that they achieve zero profits in equilibrium. Stiglitz and Weiss by contrast consider an imperfect credit market in which banks cannot observe the types of the borrowers. With two borrower types, that means that a bank does not know whether a safe or a risky borrower is applying for credit. They assume that all borrower types have the same expected return, but riskier projects offer a higher return in case of success (because of the standard debt contract that has limited upside and 100% loss downside), at the cost of a lower probability of success compared to safe projects.

At any interest rate, the expected profit is thus higher for the risky borrowers than for the safe borrowers. Therefore, the risky borrowers are willing to pay a higher interest rate and still make non-negative profit. So it would be effective for a bank to charge lower interest rates from the safe borrowers and higher interest rates from the riskier investors, but because banks lack the knowledge of the risk types, they set a common interest rate for both borrower classes, which yields zero profit. An equilibrium with credit rationing is necessary for banks give credit to both risk types at a common interest rate. Safe borrowers effectively cross subsidize risky borrowers. This is an inefficient outcome because it rations safe borrowers.

Notice this is inefficient because lenders make safe borrowers subsidize risky borrowers, because of ‘imperfect information’. Yet, banks usually do not have zero information on borrowers as Stiglitz and Weiss assume, but rather, imperfect information. Risky borrowers, via FICO scores and down payment (ie, equity investment in the collateral), pay more on average. In contrast, the major government initiatives, such as Health Care programs, charge everyone the same, which is why people don't like these programs when they aren't cross-subsidized by the non-participants (eg, Medicaid). Thus, to the extent charging everyone the same is inefficient, it is much more prevalent in government initiatives than private ones. Yet, because he proved the market is imperfect relative to perfect information, Stiglitz then merely notes this proves markets are inefficient, and thus government is better, a highly dubious inference given the way government works even when lots of information is available (ie, without a pnl objective, or better information, or less irrationality or selfishness by individuals working for the government).

In sum, Stiglitz generates the same platitudes you hear from typical far left-wing types (eg, the market is inefficient therefore dominated by government, the market leads to a race to the bottom). His arguments supporting his policy preferences are inconsistent. His Nobel prize winnung research did not, does not, forcefully prove we should always be increasing government as he assumes (he notes government gave us the internet, biotech, and ‘research and developement’ --i.e., Tang).


Anonymous said...

Putting aside irreducible ideological differences (market fundamentalists think that there should be no regulations, leftists think that every time you go to the store there needs to be a new law passed dictating your purchases), I find your continued insistence that the CRA played some integral role in the financial crisis baffling.

Let's say the government decided that there was too little investment in companies that were trying to build perpetual-motion machines. So they create a regulation that dictates that anyone willing to invest in an oil company would be required to also offer similar terms to perpetual-motion companies.

Basic economics -- I think this is micro week 3 -- says that this is going to be a pain in the ass for oil companies, and that rational investors will pull out of oil companies or try to find creative ways of investing in them while avoiding the regulation.

But there appear to be large numbers of people with a "sophisticated" understanding of economics -- e.g., people who have earned doctorates in the field -- who seem to think that this dumb regulation would have the potential to create a massive bubble, as investors start throwing their money at all sorts of oil companies, without bothering to do the slightest bit of due diligence.

It's almost as if there's something about government efforts to help poor people that just triggers a knee-jerk reaction.

David Merkel said...

Stiglitz has gone a long way on what should have been a smaller reputation.

Trivia note: The cumulative losses to common shareholders of Fannie Mae and Freddie Mac 1990-2009 are $114 billion. What a waste. Even worse are losses the taxpayers will have to bear from the bailouts.

Eric Falkenstein said...

anon: I think the CRA and the accompanying mindset was important. One may find another corporate structure to do something to avoid such regulations. But if you are taking deposits, and have over X million in deposits, you are covered by this regulation. If you are hedge fund you are not, but then, you don't originate subprime mortgages. The CRA made it highly probable that banks that failed the CRA objectives would not be allowed to acquire or be acquired, a huge disincentive in an industry with lots of mergers and acquisitions. The Federal Housing enterprises Financial Safety and Soundness Act (1992) mandate the GSEs increase their acquisition of subprime loans to lower income borrowers (this mandate kept increasing). The Fed noted that failure to comply with the Equal Credit Opportunity Act would result in lawsuits, evidenced soley by loan quotas, not risk-based analysis. Underwriting that generated adverse impact was considered 'arbitrary and unreasonable'--and so subject to lawsuit, because historically banks lost so little on mortgages. Janet Reno sued several banks on this premise. Firms like CountryWide (considered orthogonal to CRA policy by Stiglitz) was a big user of the GSE's, and generated a lot of political and ethnic group celebration because they 'served' the poor so well-their underwriting standard were almost absent. Yet countrywide was not admonished for this, they were considered best practices by the regulators because they made subprime loans that tended to disproportionatelyy help minorities. investment banks supported the new 'flexible underwriting standards by parroting official government and regulatory documents encouraging the abandonment of 'arbitrary' standards. The regulators needed government approval, so rating these pools of subprime loans better than they should have, relied on two facts: historically mortgages didn't default much (because collateral prices, homes, had always risen in aggregate), and going against the regulators on this would create political heat that would put their NRSRO status in jeopardy.

Why did housing ownership rise up to 2006? The San Fran fed argued it was from 'mortgage innovations', such as lowering Loan-to-Value ratios, documenting income, lower income to loan ratios, more adjustable rate mortgage payments applied to income ratios, etc. After the crash, the Fed announced the increased ownership and minority targets irrelevant.

Anonymous said...

Eric: there are a couple of distinct issues as far as I can see. One is whether the CRA was a good policy or not. I'll admit I don't know enough about it to debate this with you.

The issue I'm focused on is whether the CRA can reasonably be said to have sparked the crisis. To address this issue, one needs a model of bank behavior. And here's my problem with what you're saying: the model of bank behavior implied by your CRA narrative is essentially the same as Stiglitz's.

Let's take it for granted that the CRA was a misguided liberal policy, essentially forcing certain actors to engage in unprofitable activity.

If the actors are rational and smart, they bite the bullet only to the extent that they are still profitable overall. You end up with a cross-subsidy and some positive economic activity gets taken off the table, so net loss. But rational banks do not blow themselves up to satisfy some bleeding hearts. And you certainly don't end up with widespread deterioration of lending standards beyond what is needed to conform to the CRA. Not if the banks are rational.

So in your story the banks are not rational. I'm not sure what their problem is exactly. There appears to be a lot of desire to please regulators even when it is unprofitable to do so, and lots of general stupidity -- after all, it seems that a policy of making unprofitable loans is not much of of a hindrance to getting acquired by another bank. Nor does it cause any problems in getting investors to buy your mortgage-backed securities.

In fact, just as government regulators are not smart enough to out-guess the perfectly efficient market, market participants are apparently not smart enough to guess the outcomes of government intervention in the market, even though this stuff is covered in high school econ courses. The CRA was publicly available info, but it apparently its consequences were completely unpredictable, except in retrospect.

So it looks at the end of the day that the financial system, far from being a brilliant machine that turns the slightest inefficiency into money in the bank, is actually a stupid beast, easily molded by a regulatory culture imposed by economically illiterate politicians. I guess you have much more in common with Elizabeth Warren and Joseph Stiglitz than you thought!

(Read your book recently and really enjoyed it, BTW.)

Patrick R. Sullivan said...

Anon, have you bothered to read Stan Liebowitz's 'Anatomy of a Train Wreck' (from which Eric is borrowing in his reponse to you)? Your objections are all met there.

Anonymous said...

You missed the part about Stiglitz praising the economic policies of Hugo Chavez and how El Presidente is so redistributing wealth in such an equitable manner. Perhaps one of Stiglitz's many defenders can explain how 30% inflation redistributes wealth in that way.

Anonymous said...

Wow this is the longest comment I have ever written. So multiple parts.

Patrick, I just read the Liebowitz article. My objections are not all met there; in fact, I don't think any are.

Liebowitz takes to task "regulators, academic specialists, and housing activists" for undermining underwriting standards and inflating the housing bubble. My hypothesis is that if you don't have an instinctive repulsion towards these groups, you will not be convinced by Liebowitz's case for singling them out. It will not be clear why housing activists are more responsible for underwriting standards than, say, underwriters or investors in mortgage-backed-securities.

As an analogy, consider an argument that the financial crisis was caused by greedy fat-cat bankers who got giant bonuses. This is probably the most common understanding by far of the crisis. In some sense it is obviously true. But this explanation is probably much more satisfying to a liberal who instinctively dislikes Wall Street than to someone like Eric, who works in finance and understands that greed will always be with us (in fact, in many ways greed makes the world go round, and is responsible for quite a bit of good).

From a scientific point of view, determining the causes of a bad event should be quite distinct from determining the political legitimacy of various related parties. That is, we may decide to de-legitimize a party that causes bad things to happen, but we shouldn't attribute extra blame to a party just because we don't feel they should have a role in the first place.

Anonymous said...

Liebowitz notes (page 7) that nothing in the housing literature between 1990 and 2006 suggests an awareness that the onslaught of regulatory pressures to relax lending standards might possibly lead to a wave of defaults. Nothing! The reader is supposed to feel outrage at the blindness of arrogant activists and regulators and academics. Why couldn't they have left the market alone? That's right, the market... you know, the market that was *also* strangely silent on the possibility of a wave of defaults... because we all know that even the mighty profit motive is no match for the mind-killer of liberal do-gooder political correctness.

On page 11 Liebowitz finally does get around to finally asking "Why did investors get it wrong?" He calls it "one part of the story"; in my view, it is by far the most important part of the story, because that's the only part that can explain how countries around the world are suffering because of efforts to help some poor black people in America. He fudges by saying "it is not clear that any answer to this question can be completely satisfactory"... and then, unbelievably to me (I guess quite believably to you and Eric) he goes on to blame a collective mental fog (the universally terrible fear of being called a racist!) for bad investment decisions.

How blatantly unscientific! When given a choice between blaming the individual and blaming the "culture," how does Liebowitz decide? Simple: if the individual is a liberal do-gooder, then he is rotten to the core, but if he is an investor with money at stake, he is an innocent at heart, merely a victim of other people's bad ideas.

Who is to blame for the idea that housing prices can only go up, that housing is a great investment, that everyone should own a house? Why, it's community organizers and academics and regulators! Everyone else was just a victim of their brainwashing.

Liebowitz goes through sales pitches and mercilessly dissects them, but then he is unwilling to call the people who fell for them morons. He instead focuses on the bad economic reasoning in the sales pitch. I didn't realize that sales pitches were economics seminars, I thought they were supposed to help with sales.

Liebowitz makes no argument that speculative bubbles cannot form in the absence of political correctness. He makes no argument that financial markets will avoid devastating crises if they are only left to their own devices. In fact, he portrays investors as idiots, crowd-followers eager to throw money away in exchange for a warm-and-fuzzy feeling.

Liebowitz surely has the analytical skills and temperament to see through this bullshit. As an economist, he was trained to understand the importance of self-interest and to downplay moralism as a driver of human events. But I guess liberals are just really really annoying. If his article was titled "How Liberal Ideas Contributed to the Housing Bubble," that would be one thing. But he claims to be providing a scientific perspective on the entire crisis.

Why did investors screw up? Because they didn't want to be racist, and because everyone else was doing it. That's his actual answer!!!

Eric Falkenstein said...

A key point is that political pressures to increase housing for minorities, was neither necessary nor sufficient for the crisis. Being a historical event, one can't therefore prove it was causal (which would mean repeating 1000 times and seeing the probability under various environments).

In a similar way, one might say drinking caused a car wreck where the driver was drunk, drinking is neither necessary for an accident: you can have a car accident without drinking, and you can drink and drive and not have an accident. The data are mainly from what we know about how alcohol affects reaction times, coordination, and focus.

As to whether banker short-sightedness was the cause, it was definitely a mistake, and essential. Yet, no bank could really exist ignoring the CRA, they would have lost all their privileges. Many phsych studies show the power of the herd, as when Nazi's or Japanese in WW2 behaved like monsters. Most importantly, as housing prices never fell year-over-year, the lowering of underwriting standards was logically tenable, not obviously wrong. Any time a trend happens for 50 years, there will be credentialed experts saying it's an exogenous trend. Indeed, even Robert Shiller argued, in 2005, that 'housing price's recent abnormal increase probably won't continue, and that some areas may experience a decline' (read: still no year-over-year aggregate decline of significance). And this is a guy who many people assert 'called' the crash.

Anonymous #5 said...

I guess I should actually leave a name if I make 5 comments in a thread.

Look, if the crisis was truly unpredictable and no one could have seen it coming then why does Liebowitz make it seem as if it was just a natural consequence of the CRA and associated attitudes?

I mean, reading his article, you can't help but get angry at all that effort to weaken lending standards. It's so predictable!

But the banks never saw it coming either. Why not? Liebowitz's answer: because of all the liberal brainwashing.

So to wrap up.

Q: Can we change the "culture of greed" on Wall Street through better regulation??
A: No, because wishful thinking is no match for the profit motive. Aren't liberals economically illiterate morons for even suggesting that?

Q: Can we blame political correctness for the financial crisis?
A: Yes, many psych studies show the power of the herd and as a result bankers are very sensitive to the regulatory environment. Investors will gladly make bad investments if they think part of the money goes to helping poor minorities.

Anonymous #5 said...

By the way, I agree with this:

Most importantly, as housing prices never fell year-over-year, the lowering of underwriting standards was logically tenable, not obviously wrong.

But if that was true, then what does the fear of being called a racist have to do with the price of tea in China?

Liebowitz is not ironically blaming community organizers in the same way that other people may blame greedy bankers. This is the beginning of the Executive Summary of his report:

Why did the mortgage market melt down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere as risky as they actually turned out to be? This report concludes that, in an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of the government undertook an attack on underwriting standards starting in the early 1990s. Regulators, academic specialists, GSEs, and housing activists universally praised the decline in mortgage-underwriting standards as an “innovation” in mortgage lending.

He's not very subtle about his preferred scapegoat.

Anonymous said...

Man I hope you review Michael Lewis's new book.

AHWest said...

I agree with EF on lots of things, but do think that the CRA is just one of a large number of factors influencing property bubbles. The fact is, there have been property bubbles throughout history and across numerous countries that didn't have the CRA. They did almost all have central banks and governments creating credit booms however. The CRA is more of a Republican Party created scapegoat, but I think the better explanation can be found in the Austrian economic theory of credit booms and busts. Government definitely played a role. Stiglitz is of course a blind fool for seeing free market fundamentalism in an industry (banking) thoroughly regulated, directed by a central planner in the Fed, with liabilities (deposits) insured by the goverment.

najdorf said...

There's a lot of drive to call the bubble housing market irrational. Instead I would call it lots of people responding to short-term greedy incentives and an awareness of opportunities to exploit idiots. Did any of the worst actors in this fiasco suffer net losses? Most of the bankers looted enough compensation to be set for life. Most of the flippers made money for years. Pre-2000 homeowners who wanted to get out did so with huge gains. The losses mostly got put to pension funds, retail investors, and the government. Seem to me like everything went according to plan.

No one gives a neg-am mortgage because they want to hang out to collect a balloon payment 30 years from now or for noble racial motives. Be serious. Underwriting standards deteriorated because everyone in the system was playing to grab short-term money. There's enough dumb money in the world to give it to them. The semi-sophisticated people who lost big in the bubble are those who thought they could get out in time but didn't.

Anonymous said...

Stiglitz falls into the "huckster" category of Nobel winners, with Gore, Obama, and others. You'd think that the worldwide historical failure of these ideologies would give pause to the likes of Stiglitz and Chomsky, but hubris knows no governor. I wipe my rear with the "ideas" of this failed communist....

Anonymous said...

Re: CRA causing the bubble -- The innovation in mortgages didn't originate (no pun intended) with the commercial bankers. It was the new breed of lenders (Countrywide) teamed with investment bankers. The investment bankers wanted product to securitize. The easiest way to get it was to start lending to a new segment of the market.

Anonymous said...

So let me see if I get this right: Because commercial banks were incentivized to lend money to Afro-Americans in Watts (LA), it made the tens of thousands of buyers of new construction homes being built in Riverside county default?

Anonymous said...

Wall street investment banks didn't securitize and float mortgage bonds because of CRA. Moody's and S&P didn't rate the risk in those bonds incorrectly because of CRA.
So blaming CRA is just nonsense.

And I can't understand why smart, well informed people bend over backwards to come up with a reason to blame CRA ... without thinking that part of the reason has to be racism.

Patrick R. Sullivan said...

I'm distinctly underwhelmed by your supposed rebuttal to Stan Liebowitz, Anon5. Can you actually provide me with some errors on his part rather than simply implying he's a racist for not wanting Black Americans to buy more houses?
Does it not seem likely that this (quoted by Stan from the Boston Fed pamphlet):

'Did You Know? Failure to comply with the
Equal Credit Opportunity Act or Regulation B
can subject a financial institution to civil liability
for actual and punitive damages in individual
or class actions. Liability for punitive damages
can be as much as $10,000 in individual
actions and the lesser of $500,000 or 1 percent
of the creditor’s net worth in class actions.'

is an answer to your:

'Liebowitz takes to task "regulators, academic specialists, and housing activists" for undermining underwriting standards and inflating the housing bubble. My hypothesis is that if you don't have an instinctive repulsion towards these groups, you will not be convinced by Liebowitz's case for singling them out. It will not be clear why housing activists are more responsible for underwriting standards than, say, underwriters or investors in mortgage-backed-securities.'

Just for one example of his pre-empting your complaints.

Patrick R. Sullivan said...

'Wall street investment banks didn't securitize and float mortgage bonds because of CRA.'

No, but the CRA was the sine qua non that allowed Wall Street to securitize BAD mortgages that eventually blew up. Without that, we don't have anything to talk about, do we?

'Moody's and S&P didn't rate the risk in those bonds incorrectly because of CRA.'

Incorrect. As Stan Liebowitz mentions in his paper, the ratings agencies exist (as near duopoly) thanks to politicians. Cross them and your privileged position can be taken away.

travis said...

@Patrick Sullivan: How can you explain a universal decline in underwriting standards, not just in areas covered by CRA?

Also, how can you explain all the buyers of those securities willing to purchase them given the problems with the underwriting? How can you explain banks being able to raise millions from investors to sink into a business that was (supposedly) compromised by CRA?

If you blame CRA, you have to blame investors for not seeing that lowering underwriting standards would cause problems. Isn't it more likely that investors had no problem with lowered underwriting standards, CRA or no CRA?

Patrick R. Sullivan said...

Travis, I've linked already to Stan Liebowitz's paper. The explanations for your points are handled there.

Anonymous #5 said...

Gee Patrick, I'm even less impressed by your rebuttal to my reubttal.

Some poor black people defaulting on a home loan is not a financial crisis. Proving that the CRA weakened underwriting standards is not the same as proving that the CRA caused the financial crisis. It is also revealing that you blame the CRA for poor ratings because rating agencies are somewhat affected by government regulation; it shows that you are a remarkably sloppy thinker.

Travis, contrary to what Patrick claims, the Liebowitz paper contains no adequate response to your point about investors not having a problem with lowered underwriting standards. Liebowitz simply suggests that investors were victims of politically correct brainwashing and were scared of being called racist. (In fact, he actually explicitly says that there may be no adequate explanation of investor decision-making.)

Patrick's blaming the CRA for the very existence of mortgage securitization is just another sign of economic illiteracy and sloppy thinking. If investors are morons who are happy to throw their money away, plenty of people on Wall Street will be happy to create products to accommodate them. The CRA's impact on lending standards was publicly available information; if it was as bad as Patrick claims, then surely rational investors could have seen disaster coming from a mile away.

No one forced investors to buy crappy mortgage-backed securities. And no one forced any financial institution to hold less capital than it should have. (If a bank understood that regulators and rating agencies were underestimating the risks it faced, there's no reason for it to listen to those parties; regulators demand an upper bound, not a lower bound, for risk-taking.)

Of course these points have been made about 30 times in this thread now, and all Patrick has said is "Stan Liebowitz has all the answers, you should subscribe to his newsletter."

Anonymous #5 said...

One last thing: Eric (who actually is generally quite insightful about economics) defends investors by saying that the relaxing of underwriting standards was actually reasonable, not obviously wrong. He says that the crisis was basically unpredictable.

But if that was true, then why get all up in arms about the CRA? If professional investors betting billions of dollars had no idea that relaxing underwriting standards was bad, then why should community activists be raked over the coals?

Patrick R. Sullivan replies: "Stan Liebowitz addresses your point in his paper which I linked to above."

Oh OK, thanks Patrick.

Patrick R. Sullivan said...

'Some poor black people defaulting on a home loan is not a financial crisis.'

You didn't read the Liebowitz paper very carefully. He clearly states, in plain English, that the problem was speculators (i.e. house flippers) not 'poor black people', walking away from their ARMs when it was obvious that they couldn't sell their houses at a profit.

'It is also revealing that you blame the CRA for poor ratings because rating agencies are somewhat affected by government regulation...'

'Somewhat affected' = owe their very existence to?

'...the Liebowitz paper contains no adequate response to your point about investors not having a problem with lowered underwriting standards.'

Hogwash. Andrew Cuomo's pressuring the FMs into buying the loans was interpreted (correctly, as it turned out) as a Federal govt guarantee of their investments in those securitized mortgages. As Stan clearly recognized.

'Patrick's blaming the CRA for the very existence of mortgage securitization ...'

Neither Patrick, nor Stan Liebowitz, ever said any such thing, speaking of sloppy reasoning.

'If investors are morons who are happy to throw their money away...'

On US govt guaranteed investments?

'No one forced investors to buy crappy mortgage-backed securities. And no one forced any financial institution to hold less capital than it should have.'

In fact capital requirements under banking regulation--the Basel accords-- did exactly that. Again, Stan clearly understands this.

'...why should community activists be raked over the coals?'

Oh, maybe because their business models were essentially extortion.

Anonymous said...

Addressing each line one by one:

1. Speculators defaulting on their home loans is not a financial crisis either, Patrick.

2. The income tax code and the Iraq War also owe their very existence to the government officials, but that doesn't mean the Community Reinvestment Act is responsible for them. See if you can finish this train of thought on your own.

3/4/5. So no investors lost any money when the housing bubble popped, because everything was guaranteed by the government. I was not aware of this fact; does Liebowitz document this in his magnum opus? It certainly seemed that many investments declined in value even when government bailouts went into effect. Maybe that was just a bad dream.

6. As far as I am aware, regulators place minimum capital requirements on banks, not maximum capital requirements. Would you like to elaborate on how banks wanted to hold more capital but were prevented by regulators? I am not impressed by yet another the reference to Guru Stan.

7. If community activists had extortionist business models, then they should be attacked for that, not for weakening underwriting standards. Eric says that underwriting standards were not obviously wrong and that the crisis was unpredictable, even thought the CRA was very publicly available information. But if that was true, then why get all up in arms about the CRA? If professional investors betting billions of dollars had no idea that relaxing underwriting standards was bad, then why should community activists be raked over the coals?

Wait a second, I'm getting a feeling of deja vu.

Patrick R. Sullivan said...

'Wait a second, I'm getting a feeling of deja vu.'

You're not the only one.

Anonymous said...

Naja, ob das alles so richtig ist..

Anonymous said...

eric, why your focus on the cra may be misplaced...

from the recent mckinsey deleveraging study:

"contrary to conventional wisdom, the greatest increase in leverage occurred among middle-income households, not the poorest...Most borrowers who did not qualify for the prime mortgage category, in fact, were middle and higher income households with poor credit histories or no down payments, or poor documentation of income --- not low income households buying a house for the first time."

Patrick R. Sullivan said...

Okay, I'll bite; how does a program sold as helping low income people buy houses, that, in the way of all govt. programs, became subsidies for middle income people, exonerate the CRA from being ground zero in the financial crisis?

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Anonymous said...

"Okay, I'll bite; how does a program sold as helping low income people buy houses, that, in the way of all govt. programs, became subsidies for middle income people, exonerate the CRA from being ground zero in the financial crisis?"

It doesn't. The point I was trying to make was that Eric suggests the problem was poor people borrowing. It seems the bigger problem was middle income people borrowing. And I would guess the CRA was less important in ensuring the flow of credit to that income group.