Thursday, November 6, 2008

Calvin Economics: Economics and Faith?

Calvin Economics: Economics and Faith?
This comment is primarily in response to Kurt's comment on where to point fingers for the financial mess.

It is clear that blunders in and political shenanigans in the Congressional regulation of Freddie and Fannie had some role in the current financial mess, but I dispute that this was the the primary issue. I agree more with Alice Rivlin of the Brookings Institute who states:

It is tempting in mid-catastrophe to point fingers at a few malefactors or
identify a couple of weak links in a larger system and say, “Those are the
culprits; if we punish them, the rest of us will be off the hook.” But the
breakdown of financial markets had many causes of which malfeasance and even
regulatory failure played a relatively small role. Americans have been living
beyond our means, individually and collectively, for a long time. We have been
spending too much, saving too little, and borrowing without concern for the
future from whomever would support our over-consumption habit—the mortgage
company, the new credit card, or the Chinese government. We indulged ourselves
in the collective delusion that housing prices would continue to rise.

(from the speech )

Putting much of the blame on the encouragement FM and FM were given to loan to low income people does a disservice to many very good loan programs that have helped low income people own homes. To me this sounds a lot like a 'blaming the poor' for the financial mess argument. Though some of the loans granted under these programs have now gone bad, the lion's share of these loan programs were not sub-prime. My understanding of the FM and FM history is that the mortgage back securities (MBSs) that they sold to financial markets were based upon 'prime' loans (to people with good credit histories and adequate or subsidized down payments) until quite late in the game when they began trading in sub-primes to compete with the other financial houses. The MBSs with 'subprime' mortgages behind them were issued initially by the financial institutions like Lehman, Bear Stearns, etc. To satisfy world demand for MBS's that had higher rates of return than competing securities, more and more sub-prime mortgages were marketed, ie. fewer and fewer credit checks for borrowers to qualify for loans coupled with 'exotic' mortgage products that kept payments low for borrowers (adjustable rate mortgages, interest only mortgages, with 2-3 year reset dates, to name a couple).

The consequence of this was that the volume of loans, increasingly with much higher risk of default, ballooned since 2000. In 2000, there were only about 200,000 sub-prime mortgages and most were on relatively low value properties. By 2005, nearly 2.25 million sub-prime mortgages were in the market, with much higher property values as the property values ballooned. (from Christopher Waller presentation) It was not primarily low income people involved with this volume of loans. And the volume of the subprimes continued to grow, with the volume of loans requiring a reset peaking in August of 2008. Apicture from Swiss Bank captures the problem well (if only I could figure out how to insert it here) while also indicating that there is a future overhang of more recently issues Alt-A loans looming.

So, I think it is important that we see the complexity of the financial mess with the many complicit parties in it--consumers of many financial stripes wanting more house than they could afford, investors wanting higher rates of return without little (apparent?) risk, mortgage writers wanting income with little risk, investment houses wanting to boost profits by marketing large volumes of high return (low risk?) securities, government and Fed officials wanting to make home ownership possible for as many as possible, and even an economics profession that for decades has preached efficiency in capital markets if regulation is limited (see Allen Greenspan). I'm sure there are other's who bear responsibility too.

I hesitate to call this greed, for reasons Kurt mentioned in his comment. But the phrase I have used to describe the root of the financial mess is: 'a culture of manic consumerism,' fueled by very easy fiscal and monetary policy for quite a long time.

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