This article highlights the role the Federal Home Loan Banks, aka Flubs, played in building the market distortions that led to the financial collapse. Read the whole thing.
Key graph:
It didn’t have to turn out this way. In 2002 and 2006, the Federal Deposit Insurance Corporation attempted to take steps that might have discouraged the kind of excessive borrowing from FHLBs we’ve seen during the mortgage bubble and collapse. The agency proposed charging higher premiums of the heaviest borrowers. The idea was simple: Normal insurance companies charge higher premiums when more money is at greater risk, so why shouldn’t the FDIC? During the current mortgage crisis, a bank with a large appetite for FHLB loans has been the equivalent of a Ferrari driven by a teenager. [emp added]
Normal insurance companies would be those evil free-market companies run by greedy capitalists. The Flubs by contrast answered only to wise, prudent, altruistic politicians.
more:
“If you look at some of the firms whose names have been in the headlines, some of them were the largest borrowers in the FHLB system,” adds Mark Flannery, a finance professor at the University of Florida. “It suggests, with hindsight, that the ability to borrow that money might have been a factor” in the current wave of bank failures.
Gee, you think? Of course our wise and wonderful political masters understand that people play a lot more recklessly with other people’s money than with their own. They do, right? I mean, they would never create a system which used government money to induce reckless behavior, right?
I keep coming back to this central concept: The Federal government over the last 40 years has set out to distort the market in the direction of making risky loans. Now we have a crisis caused by making too many risky loans. Who do the leftists blame for the crisis? The free market.
Really, we’re supposed to take these people seriously? The banking system did just what the leftists wanted it to do and now the free market is to blame?
Why blame the leftists? Who was in power for the number of years just before the debacle? The conservatives controlled the white House, Senate, House. I hold both parties responsible.
Gee, you think? Of course our wise and wonderful political masters understand that people play a lot more recklessly with other people’s money than their own. They do right? I mean, they would never create a system which used government money to induce reckless behavior, right?
I keep coming back to this central concept: The Federal government over the last 40 years has set out to distort the market in the direction of making risky loans. Now we have a crisis caused by making to many risky loans. Who do the leftists blame for the crisis? The free-market.
Thanks Shannon. Whatever the free market’s problems may be, they clearly are small beide the problems of an economy that appears to be free and is not.
Some thought themselves virtuous; did people our congresspeople think they were caring about the “little man” or recognize that they were trying to buy votes and preen rather than earn votes and act. These people forgot the importance of subjectivity – in themselves as well as others. The hidden hand, the open marketplace of ideas, religions, etc. was built on a confidence in ourselves and a humility before the the size of the variables involved. The same people that prate about greed on Wall Street are unable to notice it, let alone consider it and take it into consideration in drafting policy.
The greed may be the bank’s who wanted more money from the federal government or the mortage holder who wanted more house than they could afford; it certainly also characterized congresspeople who wanted both the money & power that comes from retaining power. They were willing to sacrifice the next generation’s well being for a few bought votes (and sacrifice others’ dignity by encouraging the soul-destroying effects not of poverty but of moving into deep debt). The more dependent on the government. . .
This comes after a century when the slightest exposure to modern literature would see an emphasis upon the unreliable narrator and partial perspecctive. Art can’t penetrate our self-regard, whatever riches it conjures in its own, congruent reality. Literary criticism, like Barny Frank and Nancy Pelosi, assumed its practitioners were outside history and transcended human nature. Maybe we can only take so much fact and so much truth. Maybe looking at our navels doesn’t really lead to transcendence but rather narcissism. Whatever.
Fred Lapidies,
Why blame the leftists?
Because the idea that the politicians coercing people can produce a better outcome than people acting together voluntarily is a leftist idea. The institutions that created the crisis were the creations of leftist both ideological and directly.
Who was in power for the number of years just before the debacle?
The Republicans do share blame. They should have moved more aggressively to reduce market distortions caused by the GSEs. Given the existence of the distortions, they probably shouldn’t have been so cavalier about letting private institutions mimic the GSEs. However, Bush personal tried 18 times to push through reforms of the GSE during his term and got shot down by Democrats every time. For that part of the failure, the Democrats have to accept responsibility.
The truth is that the GSE were based on deceiving the market by disguising the risk of residential mortgages. This lie had to bear consequences eventually.
The truth is that the present crisis results less from leftist politicians versus rightist politician than it does from those in government versus the people. All politicians liked the idea they could give people houses without spending any money. Only a handful of libertarians over the last 40 years warned this was a bad idea and who listens to them.
We should have just accepted that not as many people could afford houses as would like to own them. We should have accepted that government couldn’t provide those people houses without actually paying for the houses. We tried to get something for nothing. Now we pay for our foolishness.
Shannon, I am contradicting a lot of your posts. And this is a libertarian blog. So, I’ll hold off for a while because it’s to the point where I think I’m starting to appear rather rude, even to myself.
But, one question before I stop: if, as you claim, the government is responsible and not the private actors who misestimated risk, how do you explain what happened in Iceland?
The banking sector of that economy had literally no regulation at all – in fact Iceland’s central bank was cheerleading deregulation. Their banking sector had the underlying problems – bad incentives, terrible risk estimation.
The difference is that their banks failed even more.
So, assuming your theory of market failure being always ultimately caused by interference in the free market, how can less regulation lead to more failure? Spectacular failure, actually. I believe every single citizen of Iceland has approximately 300K in debt stemming from the failure of three banks alone.
My meta-point is that given a set of assumptions, one can always come with explanations for events, including the current crisis. But really, if the explanations have to get more and more complex to account for all the facts, that might be a sign that it’s time to go back and look closely at the underlying assumptions again.
Wasn’t it the case, Sean, that Iceland’s problems arose because their banks bought all these securitized products out of the U.S.? They didn’t know – as few knew – that the stuff was rotten at the core. But the rottenness goes back to the policies that spawned all that unwise lending in the U.S. How would a regulatory-minded Icelandic government have known this well enough to know to legislate against it? If the legislators were perfectly wise, they’d have seen through to the rottenness and banned that sort of investment by their banks. But who thinks anyone – much less legislators – are that wise? Were you that wise?
Some of the banks here in Canada took on board this toxic stuff, and they are paying the consequence in write-offs and diminished share valuations. Our banks didn’t go as far as Iceland’s because Canadians are just naturally disinclined to novelty, especially if it originates in the U.S. of A. People are lazy – in the banking world as elsewhere. Groupthink rules. The way to deal with this is not to try to do something impossible – legislate perfect outcomes – but to punish the lazy with the consequences of their laziness.
KJ: No, actually the root cause of Iceland’s problem is credit.
Iceland removed all restrictions on capital inputs to its banking sector. The banks promptly (and unwisely) went on a gigantic international borrowing spree. Worked very well for a few years, 4% AGR, per capita income even exceeded the U.S. Then the bottom fell out of the international credit market and their banks were left high and dry.
Their interest rate has now been raised to 15%(!) because speculators are betting against the krona and they need to prop it up. Not clear that will work but one thing that we can be sure about, that cost of capital is growing to strangle any attempt at recovery for a while. Devil and a hard place.
This is a fascinating article if you’d like to know more:
http://www.vanityfair.com/politics/features/2009/04/iceland200904
Very interesting and funny article, Sean, by a real good writer. It was tulipmania time in Iceland! What did the Icelanders invest all those borrowings in? I’ve got a suspicion lots of it was the bad stuff we were packaging and selling here – dumps in Florida and the like. This was a little nation that went a bit loopy with the idea of everyone striking it rich, and now they’ve paid the price. So it goes. We don’t all want to be social workers and horny handed sons of toil.
seanF,
So, I’ll hold off for a while because it’s to the point where I think I’m starting to appear rather rude, even to myself.
The only thing that is mildly rude is your avoidance of answering questions I poise or your occasional seeming inability to grasped that I have answered a question. Your miles better than Fred Lapidies in that at least you stay on topic and ask reasonable questions. I personally don’t mind being challenged it helps me think. Back in my youth arguing with creationist sharpened my understanding of evolutionary theory. Arguing with leftist sharpens my understanding of the free-market related matters.
if, as you claim, the government is responsible and not the private actors who misestimated risk, how do you explain what happened in Iceland?
Well, (1) Iceland has a population of only 320,000. If it were an American city it would not even rank in top 50 by size. That means it is a small place with its own laws, standards and history. A mistake made by even a few dozen people could screw their entire system. Therefore Iceland’s experience doesn’t generalize. (2) The free-market doesn’t protect individual players. You bet wild, you lose. Iceland three small banks bet large by running on margin and lost. Again, that doesn’t tell us anything about whether coercive politicians make better systematic decisions than voluntary actors. (3) Iceland’s banks appear to have failed for the same reason that Maxine Water’s pet bank failed, they bet on Freddie Mac and the other GSEs. Had the GSEs remained solvent, then the banks could have survived.
So, assuming your theory of market failure being always ultimately caused by interference in the free market…
Markets fail all the time, they just fail small scale. Look at the computer industry over the last 30 years. Companies have risen and fallen all over the place but you never seen a failure that took down the entire industry. Something that wipes out the entire industry, even a networked industry like finance, has to be generated by a large external force such as government. All the depressions of the 1800 up through the present day have their genesis in some large scale government action. So did this one.
… how can less regulation lead to more failure?
Because the most regulated and interfered part of the financial system collapsed while the least regulated and free parts of the system e.g. the commercial mortgage segment, did not. Now, I realize that correlation does not prove cause but if you look at to similar market where one failed and the other did not then the primary factor differentiating the two is most likely the cause.
Real world regulation doesn’t work like it does in the ivory tower dreams of leftist academics. You should view politicians exactly as you would view a corporation the only difference is that the politician seeks power instead of money. Modern campaigns are just corporate marketing writ large. Politicians do whatever they need to do to get votes. Over the last 40 years, the major vote getter has been seeing that more voters could own homes. The “regulation” you so prize has been totally skewed towards that end. The point of regulation was not to protect the long term integrity of the banking system because most voters have no understanding of high finance. They did understand whether they could get a mortgage or not.
Politicians won’t regulate their own vote generating corporations. This is what happened with the GSEs. Politicians, largely Democrats in this particular case, set up the GSEs and then provided them with custom laws and accounting standards that were far, far less strict and much more secretive than those used by private institutions. Combine that with the enormous size of the this political corporations and you have a recipe for disaster.
You need to explain why the real world political system, especially the supposedly wise and alturistic leftists, failed to regulate their own creations. If they can’t do that, how can they regulate private institutions?
To repeat myself ad nauseam: This crisis was caused by lenders making to many risky loans. It has been the policy of Federal government to induce and even bully lenders into making loans that the free-market judge to risky. That means no government intervention, most likely no large scale problem.
Iceland’s banks ultimately failed because they trusted the U.S. government to regulate its own creations. More fool them. They certainly were not alone. Everyone from Maxine Waters to AIG to thousand of foreign investors got suckered as well.
Shannon,
Actually, I do try to answer your questions although my explanations may always track your individual comments.
The reason I’m going to take a break from criticizing your posts is simple: I think we’ve had an engaging discussion that has been fun. But, I’m not sure I have much more to add at present – in terms of analysis – that I haven’t already said in one form or another. Disagreeing with you simply for the sake of disagreement isn’t very productive.
I think we’ve also sharpened the real differences here. While I think we both agree that any sort of intrusion on personal liberty is undesirable, you think regulation of any sort tends to hurt free markets – and you accord economic efficiency a priority.
I think free markets work best when subject to sensible regulation designed to prevent gaming or unfairness, even when the regulation comes through the messy political process. And while allocative efficiency is important, I believe that the distributive effects of unrestrained markets injure other important values – dignity, political stability, equality, and equality of opportunity. From what I’ve been able to see, these normative assumptions really lead to our disagreements on policy positions.
To answer your question above: Iceland was hurt by the US sub-prime meltdown but only because of the collateral effect on credit markets. The real cause was, as always, a combination of bad incentives and inevitable greed. Their bankers chose risky short-term gains over more prudent strategies because they didn’t have personal liability for the downside.
Just like e.g. Countrywide in the US – same incentives, same problem. In fact, what we’ve really had over the last few years in the US is socialism, but only for the elite. Socialism because we collectively pay for failure, by having to bail out our flawed banks through taxpayer money. But only for the economic elite, because only the bankers and financial executives get to enjoy and keep all the upside short-term gains. As AIG executives are currently trying to do with their bonuses.
Anyway, I’ll be taking a break from posting for a while. Although I like to think I’m an original thinker, a common enough delusion, my opinions are probably a fairly conventional statement of current thinking on the left. If I have something substantive to add in future, I won’t be shy.
Greed is inevitable: to complain of it is as sensible as an archiect complaining about gravity-it is his job to make the building resist gravity. So is it the job of the polity to resist the ill effects of human vices.Instead we get politicians who infantilize the public for their own gains.
I have one question. Why would anyone expect a regulator to be less greedy than the people they regulate? People in the private sector may be presumed to be adding value(in the absence of regulation). We can make no such presumtion of public sector workers. I speak from personal experience too,having worked as a civil servant.