James Galbraith has a pretty good summary of the roots of the financial crisis at The New Republic. I will summarize the summary. (Eventually, if we abstract this enough, it’ll boil down to “stuff happened, people got screwed.”)
1. The regulatory framework for financial institutions was weakened, allowing the casino to open.
2. The lack of standards led to fraudulent practices in the home mortgage industry – applicant financial information was mostly unverified; appraisals were little more than fabrications; mortgages built to fail were created (e.g. consumers were sold loans with teaser rates that would reset into something unsustainable.)
3. These notes would be bundled together, AIG or some other “insurer” (without anything close to the assets necessary to cover the risk) would essentially guarantee the value of the loans. Ratings agencies would proclaim these notes sound investments with little basis for making such a claim. And with this fairy dust sprinkled over the big shitpile, the notes were sold as AAA investments to pension funds and the like.
One of the consequences of deregulation was that insurers like AIG were allowed to use proprietary risk models as a way of determining the assets necessary to insure these financial products. The risk models did not accurately reflect the actual risk. Using these proprietary models is a little like trying to develop an encryption system with no external tests. You might mean well, and it might even look great to you; but without neutral or even hostile parties whaling away on it, you can’t know how effective it will be in the real world. And the short-term financial incentives were stacked toward encouraging rosy predictions.
Robert Reich suggests that the rising percentage of the country’s wealth appropriated by the very wealthy was the proximate cause of the meltdown:
Consider: in 1928 the richest 1 percent of Americans received 23.9 percent of the nation’s total income. After that, the share going to the richest 1 percent steadily declined. New Deal reforms, followed by World War II, the GI Bill and the Great Society expanded the circle of prosperity. By the late 1970s the top 1 percent raked in only 8 to 9 percent of America’s total annual income. But after that, inequality began to widen again, and income reconcentrated at the top. By 2007 the richest 1 percent were back to where they were in 1928—with 23.5 percent of the total.
Each of America’s two biggest economic crashes occurred in the year immediately following these twin peaks—in 1929 and 2008. This is no mere coincidence. When most of the gains from economic growth go to a small sliver of Americans at the top, the rest don’t have enough purchasing power to buy what the economy is capable of producing. America’s median wage, adjusted for inflation, has barely budged for decades.
(emphasis added). (It’s a little odd to me that, when the owner of capital uses superior bargaining power to extract more work for less pay, that’s just business. When the masses, using the tool of government, uses superior bargaining power to extract more pay for less work, that’s tragically unfair. Seems to me either a basic sense of fairness or a mercenary willingness to use any tool available in negotiation should be applied to both scenarios equally.) Both articles suggest strongly that President Obama has missed a trick here; he had an opportunity to right that which went wrong and, instead, seems inclined to go back to business as usual. Because he didn’t take Big Money to the woodshed, we’re doomed to repetition because the underlying problems have not been addressed.
What about when the owners of capital use the tool of government? Is that fair or unfair?
I think you’re right about the government being composed of tools, btw…
How much bargaining power does the owner of capital have in a developed economy in the 21st century? Significant natural monopoly and monopsony power are troubling but rare. In any case, the owners of capital (and human capital) acquire far more power through government than markets.
once again, the lack of regulation led to our demise. Somehow, the hate groups at faux news tried to make it seem as if these companies were forced to make loans to the poor people. I wonder what would have happened had they got social security monies privatized? wall street is nothing but gambling. the only people who make money are the few and the brokers. That is what they are called–brokers, because they cause you to go broke.
How can someone (confidently) tell the difference between the impact of a lack of regulation, too much regulation, and unenforced regulation? In any case, if one is too big to fail, then the ultimate “regulation” is knowing that monies will be taken to subsidize your risky investments.
Blaming the recession on too much income to the rich makes little sense to me.
Of course the percent of income going to the rich will peak the year prior to a recession. The rich generally make most of their money on capital investments, rather than labor like the rest of us. In a recession (2009), those capital investments not only don’t make money, but they actually lose money, making the disparity between rich and poor much smaller, thus reducing the “peak”. However, in general EVERYONE did worse in 2009 than they did in 2008, and bringing the “top” down closer to the median does nothing to actually improve the economics of the less well-off.
Let’s also remember that the late 1970’s (when “the top 1 percent raked in only 8 to 9 percent of America’s total annual income”) was not exactly the best financial time in our nation’s history, either.
Akla: Have you heard of the Community Reinvestment Act? It seems to be more than just a creation in the mind of Fox News. http://en.wikipedia.org/wiki/Community_Reinvestment_Act
The amount of CRA’s responsibility for the 2008 financial crisis is disputed, but even its most ardent supporters recognize it has some culpability.
The amount of CRA’s responsibility for the 2008 financial crisis is disputed, but even its most ardent supporters recognize it has some culpability.
they most certainly do not.
http://www.americanprogress.org/issues/2008/09/cra.html
From the “progressive” article cited by stAllio:
“Non-bank mortgage companies, which aren’t covered by CRA, originated an estimated 50 percent of subprime loans in 2005, for example, according to testimony from Center for American Progress Senior Fellow Michael Barr. It is these institutions that mostly started to collapse at the beginning of the crisis. Another 30 percent of loans were made by subsidiaries of banks or thrifts, which are allowed—at their option—to use loans made by these subsidiaries to count toward their CRA rating.”
Let’s see…. If I add the 50% that isn’t caused by the CRA (at least according to the progressive website you cite), and I don’t use the 30% (which MIGHT not be caused by the CRA) (were these loans done as an attempt to comply? – Unknown ), I still only arrive at 80% non-causation by the CRA.
Thus, even the article you provided admits that 20% of these loans were used to conform with the CRA. 20% of the current housing crisis seems to be a big deal, no?
Either way, the CRA goes a long way towards being the federal program mentioned by Akla, who said: “Somehow, the hate groups at faux news tried to make it seem as if these companies were forced to make loans to the poor people.”
(I have to figure out how to bold, use italics, in web postings).
To paraphrase Warren Buffet: ‘There is always class warfare and my class is winning.’
I might add that is almost always thanks to tea party types in any era who somehow think they are capitalists on a par with Buffet and other ‘Economic Royalty’. We do have socialism in this country, but the risks are all socialized (bailouts) , and the profits are always privatized.
you’re misreading the article.
First and foremost, CRA was enacted in 1977 to reverse so called “redlining” in the 1960s and 1970s—long before subprime mortgages at the heart of the current crisis were ever made
i.e. the program had been in effect for 30 years… and yet somehow it suddenly started causing problems decades later?
Second, when CRA was passed in 1977, it was designed to cover only depository institutions—commercial banks and savings-and-loans institutions, or thrifts
this is the 30% group. the remaining 20% of subprime loans were not CRA. of that 30%, some percentage were CRA loans.
and finally,
by fostering competition among banks in serving low-income areas, CRA generates larger volumes of lending from diverse sources and adds liquidity to the market, decreasing the risk of each bank’s loan.
in short, the CRA requires certain institutions to issue loans within their own neighborhoods, including in poor neighborhoods. it doesn’t require them to make “bad” loans or lend to people whom the bank knows can’t afford them. the banks did that all on their own… and the worst offenders were not CRA banks.
anyway, that was just the first link i found. i only posted it to dispute your claim that everyone agrees the CRA “has some culpability” in the housing crash. to be frank, i don’t know anybody who believes that who isn’t either a clinton-hater or an apologist for the finance industry (or both).
(1) A simple read of the Wikipedia entry I linked to would show the following quote:
“Economist Stan Liebowitz wrote in the New York Post that a strengthening of the CRA in the 1990s encouraged a loosening of lending standards throughout the banking industry.”
In other words, the CRA of 2007 was not the CRA of 1975.
Either way, the point is that the CRA was symptomatic of America’s love affair with home ownership, and remains bad policy.
2) Your comment about being a “Clinton hater” made me laugh. Clinton and Bush both screwed things up. Anyone that says different is a Bush/Clinton apologist!
3) While the CRA doesn’t force “bad” loans, it does require banks to make loans, thus pushing banks to make more “marginal” loans, in fulfillment of their quota. The increase in loans increases the money supply in these poor neighborhoods, and thus increases prices. When the bubble crashed, the value of these homes (which appreciated at levels in singificant excess of inflation), also crash.
Note that I have not stated that the CRA was the only factor in this increase, but it was A factor. To deny it as a factor at all is to argue the sun revolves around the earth. It says more about you than anything else.
i beg your pardon.
liberal economists do not believe CRA was a significant factor in the housing crash. krugman calls the idea a “zombie myth” that has been “refuted up, down, and sideways”. and he’s far from alone in that opinion.
if i wanted to, i could spend hours posting links to refutations, many of them brimming with wonky economic data, but clearly that would be a waste of my time. you have already decided that my position is wrong, just so much geocentric denialism.
have a good time believing you’re right. i’m done here.
From http://www.nytimes.com/2010/07/09/business/economy/09rich.html?_r=3&hp :
“Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.
More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.
By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.”
But remember, its housing loans in “poor neigborhoods” that cause all the problems.
I read Paul as saying the CRA was “a” factor. Where I think he was wrong was saying that it’s most ardent supporters admit it bears some culpability. I read stAllio! as trying to refute that particular assertion.
What we are left with is, I think, to ask whether the CRA was a significant factor. In other words, does it rise to a level of importance comparable to the other factors (such as the factors mentioned by Galbraith?
I’m not accusing Paul of this, but in general, I’ve seen the CRA used as a talking point among those who seem more comfortable seeking to blame do-gooders and poor people. The problem comes when the casual observer (and voter) hears the argument but can’t (or doesn’t bother to) evaluate the relative merits. Instead, such folks are likely to just throw their hands up in despair, concluding everyone (and, therefore, no one) is responsible.
So, the Krugman post calles it a “myth”. However, even the study behind the Krugman “zombie” piece (Krugman’s blogpost is a 3 paragraph summary which does not discuss details) admits that 9% of subprime and 31% of prime loans) are from this CRA program.
Doug – That is a fair (and correct) reading of my posts. Perhaps I should have inserted the word “reasonable”, as it seems (to me, anyway) that reasonable people would believe/understand that forcing lenders to make loans to poorer communities could likely lead to higher default rates. (I recognize that does not mean that the CRA does not have positive characteristics as well). However, it is hard to completely deny that the negative aspects include a contribution to the housing collapse.
I don’t know if anyone can honestly tell if it is a 1% factor or a 15% factor, but it certainly isn’t a creation of Fox News as was originally suggested.
doug: paul’s primary error, which he continues to make, is that he conflates intuition with reasonableness.
the idea that “forcing lenders to make loans to poorer communities” might “lead to higher default rates”, thus contributing to the housing crash, is an intuitive one. and of course CRA could have done that had it been poorly implemented, which is why the act actually states that CRA lending must be “consistent with […] safe and sound operation”.
but the question isn’t whether this could have happened, but whether it did. paul assumes that it did, based on his intuition, and defines his assumption as “reasonable”. but if his position is the reasonable one, then anyone who disagrees is by definition “unreasonable”, regardless of the merits of their actual argument. (this is known as the “no true scotsman” fallacy.)
intuition isn’t always right, and in this case, the data doesn’t support the idea that CRA played any real role in the housing crash.
for a detailed history of the CRA, i recommend former comptroller ludwig’s recent house testimony. he was in charge of clinton’s ’94 regulatory reforms, so he’s extremely knowledgeable, though obviously has an interest in presenting CRA in a positive light.
I will make some notes of my own, as an attorney who formerly was in-house counsel for a sub-prime lender, and who now represents lenders in foreclosure and bankruptcy cases. Being a Democrat, that gives me something of a unique perspective.
To my knowledge, government NEVER “caused” or otherwise gave incentives to lenders, esp. non-bank lenders, to make sub-prime or otherwise risky loans. That is a conservative urban myth. Lenders made such loans BECAUSE IT MADE THEM MONEY TO DO SO.
Prior to massive de-regulation which allowed insurance companies to become investment houses, hold mortgages, and also bet against them, all of the risk factors were separated, creating real market incentives to minimize risk. Along came deregulation, and the scene of insurance companies with excess capital deciding to become lenders (Conseco is one slightly non-apropos example). Risk evaluation went out the window with the discovery of marvelous tools of greed called derivatives. Then you had insurance on the derivatives (credit default insurance) and turned both of those into items that could be traded, mostly without regulation or even market oversight. Even derivatives were re-packaged into derivatives of derivatives, and NO ONE KNEW WHAT THEY WERE WORTH OR WHAT THE RISK WAS. In short, they were selling empty air, making valuable trade items out of bad loans with an unknown default rate.
It’s more complex than that of course, but that gives an idea. To get a better notion, read the current best-seller “The Big Short”. So, lenders could make any sort of bad loan, without documentation in many cases, and sell it for high value with no risk to themselves. It was the AIG’s and Bear Stearns and Goldman Sachs of Wall Street that turned this into a global mess out of pure greed.
For the conservatives who are against any sort of government regulation of just about anything, the reality of this is their worst nightmare. Their dogma caused the current financial mess, and they cannot admit it, even to themselves.
Not completely true. It used to be that Fanny-backed loans required very stringent requirements. The prime loans went there, and there was a whole other industry for sub-prime. A group that took the loans the government wouldn’t back, and they made a good deal of money on that.
Then, when the government relaxed its standards and started accepting less than prime loans, the industries that relied on that market were faced with going out of business or finding even more risky loans. Loans they used to reject.
Now, I’m not blaming the whole thing on the relaxing of government standards, but it did play a role. A much smaller one than derivatives, but it was still part of the problem.
James Galbreath is a brilliant honorable man, who when younger, turned down the opportunities offered him by the elite, to sell out thew American people. President Barack Obama works for Goldman Sachs, and that means more destitution and serfdom here and abroad.
And some more perspective on political vs. financial causes:
Easy Credit Hard Landing