Joe Doakes from Como Park emails:
Time for the monthly newsletter. Senator Franken’s projects and grades:
Preventing the Next Financial Collapse. Al is working on amendments to banking law relating to credit ratings. Sorry, Al, but phony credit ratings didn’t cause the collapse, that was a combination of existing government regulations: CRA forcing lenders to make bad loans in the name of affordable housing, FNMA downgrading its definition of “prime” to guarantee the bad loans, Chris Cox at SEC suddenly implementing “mark to market” rules that panicked investors and triggering Lehman Brothers bankruptcy. All those regulations remain so tinkering with credit rating law isn’t even closing the barn door after the horses are gone, it’s more like gilding the weather-vane on the barn roof, worse than useless. Grade: F.?
As the economy “recovers” but never improves, it’s necessary to keep up appearances by continuing to try to throw blame off of government, for the benefit of the low-information voter.
Creating Jobs with the Energy Section of the New Farm Bill. Al’s really proud of this section, it’s chock full of subsidies for wind, advanced biofuels, biomass, the whole nine yards. We’re sure to wean off foreign oil this time! Geez, Al, ever heard of Solyndra? If you want to make America energy independent, open up federal lands. The President brags that his administration has signed leases to look for oil, but forgets to mention that they denied permits to actually pump the oil. North Dakota is showing the world that the best way for government to help energy production is . . . get the Hell out of the way. Throwing another boatload of money down the same Alternative Energy rathole will produce jobs only for smooth talking hucksters. Grade: F.
Upgrading Minnesota’s Water Infrastructure. Any time a Democrat talks about infrastructure, I grab my wallet. This bill might be the exception to the rule. He’s talking about the Water Resources Development Act, which is Congress’s way of funding a bunch of water-related activities ranging from flood control to water treatment plants to wetland preservation projects. It comes up for renewal every few years and contains most of the funding for the Army Corps of Engineers, for example. We always can nitpick particular line items but as spending bills go, this one isn’t too bad. Control of federal waters is a reasonable component of regulating interstate commerce so this act is more Constitutional than most. Grade: C+.
Breaking the Veterans Affairs backlog. Al, in the Senate, and Tim Walz in the House, introduced the Quicker Benefits Delivery Act. It prohibits the VA from requiring additional medical exams by in-house doctor if the disabled veteran already provided one from a non-VA doctor. They also tinker with the rating system for full or partial disability, hoping this will speed claims processing. Veterans are a federal responsibility so this is Congress’ job and the backlog is a disgrace. We spend millions of dollars every hour sending men and women to fight wars all over the world; the very least we can do is take care of our disabled vets when they come home. I don’t know enough about disability law to know if it’ll work but kudos to Al for at least trying to do something to make it right. Grade: A.
GPA this month: D
It’s a gift.
Actually he gets a D on the VA backlog. Every politician is making polite noises on this, but the problem at the VA is systemic, and probably a lot closer related to Mitch’s post above about keeping veterans in line, dependent on the government, and above all quiet about their situation.
“..phony credit ratings didn’t cause the collapse, that was a combination of existing government regulations”…..
Wall Street and under/unregulated securitization did this. Derivative products that were insurance and not regulated like insurance did this. The co-mingling of investment and banking did this.
I can remember when congress created a panel to look into this. All four Republican members of the panel voted to ban phrases such as: “Wall Street” and “shadow banking” and the words “interconnection” and “deregulation” from the panels final report.
If someone were to imply that Wall*Street vis a vis deregulation and interconnection through their shadow banking facilities, was able to make off with the cookie jar and then some, that would be downright scandalous.
I really don’t think we have learned anything from the last banking crisis. World wide Governments deeply in debt with huge spending problems are making loans to Governments even more deeply in debt with even bigger spending problems. The problem I have with the Credit rating agencies is that my belief is they are painting a far to rosy picture.
Senator Stuart Smalley believes in grade inflation because we are good enough, smart enough and Dog Gone it, people like us.
Commenter “Not Sure”/Doug Grow wrote… “If someone were to imply that Wall*Street vis a vis deregulation and interconnection through their shadow banking facilities, was able to make off with the cookie jar and then some, that would be downright scandalous.”
It was a scandal. If you were a real estate investor like me who in the Bush ’41 era sweated out the 20% downpayment investment property required (at 9.5% interest on a 30 year loan) only to watch Bill Clinton decide that the way to create more middle class people was to lower downpayments and credit requirements, you saw it coming. His Justice Department and HUD went after banks (‘banksters’ for you low info types) that wouldn’t play ball and loan to the high risk no nothings that did treat their equity like a piggy bank. The Wall Street Journal railed against Fannie Mae & Freddie Mac’s socialize the risk and privatize the gain business model in the late ’80’s/early 90’s (those cretins). Both agencies were way stations for out of power government staffers who – amazingly – got Congress to tie their 6 & 7 figure bonuses to the amount of money they had out on loan, not on how well those loans performed. The fact that Dodd/Frank merely doubles down on this socialize the risk and privatize the gain business model – with fewer but much larger banks, is a sign that no one really learned anything from the real estate implosion.
“Wall Street and under/unregulated securitization did this. Derivative products that were insurance and not regulated like insurance did this. The co-mingling of investment and banking did this.”
Once again Emery firmly stuffs his head up his arse.
Credit ratings…..Obama loves the disparic (can’t spell it) impact. He noted that blacks and hispanics overall have lower credit ratings than whites and Aisians. Solution? Solve the problem the causes low credit ratings? No.
Obama is ordering the credit raters not to give minorities such low ratings.
So when you decide how much to loan someone, you don’t know if the credit rating in front of you is real or artifically raised.
Chuck is correct.
Similar to deciphering job applicants’ GPAs and college transcripts.
Well, JPA, I have to agree with “Not Sure” on this. But the reason the banks could co-mingle the derivatives with with their other investments was that when the bubble popped, Uncle Sammy guaranteed that their depositors would be made whole. Fannie & Freddie were buying up the loans, regardless of quality so the banks made their money on the fees then sold the loans in pools to Fannie & Freddie. Fannie & Freddie management was bonused based on loans outstanding – so win, win, win for the banks, the execs and the non-creditworthy.
Holman Jenkins of the Wall Street Journal has a good proposal here. The Feds should stop insuring the whole bank. They should only guarantee the bonds issued by the government that the bank holds. All of the sudden, bank management has a lot less taxpayer money to play with and they get responsible real fast with their depositors and investors money. It will end the so called Amurrrr-i-can Dream of owning your own home for the irresponsible, but for those of us who see paying our bills including our taxes as an obligation, not an option, our money is much more secure.
Seflo, it all started with Affordable Housing Act and Fed guarantee (which happened BEFORE the bubble). THAT led to comingling, etc. (have you ever neglected to pick up a quarter you found lying in the dirt?) THAT led to the bubble and its inevitable bust.
Chuck-
It is ‘disparate’ impact, meaning unequal impact.
Judging things by ‘disparate impact’ means that you aren’t going for a so-called level-playing-field, you are going for equal outcomes.
This is un-American. Federalist 10:
The banks were able to show that minorities and non-minorities suffered nearly identical rates of foreclosure. This meant that they were appropriately calculating risk. Not good enough for Barney Frank and friends.
JPA; turn that frown upside down.
There were others speaking out about the pending subprime crisis, Robert Shiller, Tom Lawler, Dean Baker, Doris Dungey and others. There was discussion of loose lending standards (including, but not limited to subprime), lack of regulatory supervision, agency problems with the originate-to-distribute model, and more. And although we might have disagreed on the exact causes of the bubble, as far as I know none of the people who are commonly credited with identifying the bubble, and predicted the bust, blamed it primarily on Fannie and Freddie or the Community Reinvestment Act (CRA). The vast majority of subprime loans were written by private label entities which were not subject to CRA lending requirements.
The vast majority of subprime loans were written by private label entities which were not subject to CRA lending requirements.
I think that misses the point, Emery.
It would be interesting to see a graph showing how many Americans, as a percentage of population, qualified for prime and. subprime mortgages over the last half century or so.
If the immediate cause of the bubble was the packaging of mortgages into securities, what made the practice of packaging mortgages into securities possible?
It is a complex topic. I’ve seen charts that show that virtually all of US GDP growth after the dot-com bust came from financial services. When the bubble in financial services collapsed, it knocked us back to yr 2000 levels of growth, and we’ve been stuck there ever since.
Very well put Terry.
If anyone would care to get “ubernerdy” about the mortgage industry from an insiders perspective here is a link that I find useful.
/”The Compleat UberNerd”/
http://www.calculatedriskblog.com/2007/07/compleat-ubernerd.html
For those who might prefer something less nerdy. I suggest “Liar’s Poker” and “The Big Short” by Michael Lewis who wrote Moneyball.
Read “Liar’s Poker” to learn more about the evolution of financial services. Then read “The Big Short” for a discussion about the mortgage crisis. The lawsuits surrounding the book and its publisher will certainly attract more appreciative readers to Mr. Lewis’s work.
Doug, perhaps you could explain how Al’s credit-rating idea will prevent another price bubble in housing, will prevent investors from buying high-risk derivatives, will prevent Congress from trying to reshape society with subsidies, directives and guarantees. Because at this point, it looks like blame-shifting.
Reminds me of the Governor blaming industry execs for the shortage of revenue from electronic pull tabs when the real problem is legislators willing to use any fig leaf to excuse the policy decision they had their hearts set on.
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The vast majority of subprime loans were written by private label entities which were not subject to CRA lending requirements.
Because they were guaranteed by the government! How obtuse are you, Emery? Really!
One of the reasons not to trust mainstream reporting on virtually any topic is that they will push a narrative rather than tell you, the media consumer, the truth. They will not tell you what you need to know.
-‘Financial services’ is essentially risk management. ‘Financial services’ is reliably measuring risk/reward in regard to investments. The financial services companies, despite being staffed by certifiable geniuses, were terrible at this. It is why the crash happened and why recovery has been so slow.
-Globalization was supposed to make us all richer while eliminating, or at least minimizing, downside risks. All the smartest people said so. This did not happen.
The roots of the crisis of 2008 can be found in the 1980s when complex financial products like mortgage derivatives were developed. These financial instruments (which had names like the synthetic subprime mortgage bond-backed C.D.O., or collateralized debt obligation) grew increasingly opaque and complex to help obscure the fact that they were built around increasingly suspect loans: “low-doc or no-doc loans” requiring little documentation, adjustable-rate mortgages that ballooned after two years, “interest-only negative-amortizing adjustable-rate subprime” mortgages, and mortgages given to migrant workers and immigrants.
Wall Street firms were able to hide the risk by complicating it and by getting the rating agencies notably, Moody’s and Standard & Poor’s to give triple-A ratings to bonds that were far lower in quality. Why, were Moody’s and Standard & Poor’s willing to bless 80 percent of a pool of dicey mortgage loans with the same triple-A rating they bestowed on the debts of the U.S. Treasury? Because, Wall Street firms knew how to game the system; they knew how to get the rating agencies (which were eager to collect big fees for their services) to ineptly rate dangerous bonds. Most evaluation models, were based on rising house prices and used the foreshortened, statistically meaningless past to predict the future; this was how the entire food chain of intermediaries in the subprime mortgage machine was able to dupe itself.
I was around when Orange County went bankrupt because the County Manager invested all the tax receipts in derivatives, and those were highly rated, too. Derivatives are not something new invented to cause the housing bubble and collapse, Doug.
Credit ratings make no difference to derivatives because the event that makes them risky is always external to the specific loans, e.g. interest rates drop so everyone refinances out and your payment stream dries up. The entities that were allowed to buy shares in mortgage pools were the size of Royal Bank of Scotland, Deutsche Bank and Credit Suisse. International investment bankers know damned well what derivatives are and why they’re risky, which is why they also bought credit default swaps and mortgage insurance. The credit ratings set the per-share buy-in price but not the risk and everyone involved knows it. Lowering the credit ratings would have lowered the buy-in price but would not have affected the risk or the willingness to purchase.
Doug, you discount the Community Reinvestment Act as a cause but then cite no-doc loans as a problem. Yes, and why were they developed? To justify giving loans to people who couldn’t otherwise qualify for them (immigrants and minorities) to increase lending to bad risk borrowers, to meet CRA requirements, which Congress set. Again, lowering credit ratings wouldn’t have stopped Congress from passing idiotic social-leveling legislation. In fact, Jamie Gorlick at Fannie Mae lowered underwriting standards specifically to be able to guarantee more bad risk loans.
Finger pointing isn’t problem solving. “It’s complex” and “I don’t know” don’t solve problems. Tinkering with credit ratings won’t solve the problem, either.
It’s not that I don’t think Fanny & Freddie played a their part, but because of the restrictions on their lending capabilities, I think its hard to pin them as the primary cause of the mortgage meltdown. The lending itself was the prime mover.
Further up the food chain, the investment banks really seem to have believed that their quants had magically squeezed all the risk out no matter how much leverage was applied.
Regulation? Who needs regulation of product Moody’s, Fitch and S&P kept giving AAA ratings to?
It is distressing that the people who think that larger, more interlocked banks will lead to disaster also believe that larger, more interconnected governments will lead to heaven on earth.
The lending itself was the prime mover.
That’s absurd.
The lending wouldn’t have happened without the policies – all of them – that led the government and industry to socialize all the risk of that lending, but privatize the reward. There was no downside to investing in subprime loans. So the investors got wealthy, the public sector took an epic bath, and the Obama Administration has spent the past five years spinning the disaster as a failure of capitalism when it is in fact nothing that a modestly bright Econ 101 student couldn’t have predicted.
@Terry: Good one; excuse me while I go sniff a flower…
@ MBerg:
Are you implying that I believe Frannie and Freddie did not have a role to play in this crisis? They did have role to play. I just don’t believe F&F to be the “primary” cause of the crisis. F&F may have introduced some distortions and created perverse incentives in the mortgage market but these were not the driving force behind the tremendous growth of subprime and Alt-A loans in the private market.
Did F&F buy high-risk mortgage-backed securities? Yes. F&F pursued the riskiest loans not to meet the affordable housing mandate, but instead to increase profit, as they were assumed to be higher yield. I also agree that F&F held substantial amounts of subprime mortgages and their holdings of these securities played a significant role in their demise.
The bad stuff didn’t start happening until after the Fed-sponsored transfer of mortgage backed security origination from F&F to Wall Street was complete and everyone joked that, “If you can fog a mirror, you can get a home loan”.
Making loans to people with low credit scores, with no down payment (no-doc loans or liar loans). With no proof of income or assets and just an enormous amount of risk layering what was going on. It doesn’t take sophisticated financial analysis to predict that loans made without any meaningful underwriting by the mortgage lender contributed to the crisis.
I also view low rates as an initial contributor, not the cause. It helped enable the development and subsequent exploitation of the system. There was an institutional credit failure along with investor naivete . The old “if a little bit is good, then a lot is even better mentality” came in to play. Toxic sludge (ARM’s, ARM’s credit qualified at teaser rates, Subprime, 100% LTV’s, Stated Income) grew at ever increasing proportions as the product was abused by everyone in the system. The most significant failure rates apply to the last two or three years of securitzed products produced by those concentrating in the toxic sludge arena. I’m guessing that this is also true in credit cards, auto and any other type of loan as well. Risk pass thru turned lenders and investment banks into pure commission driven sales agents with no regard for the product sold. The securitized model assumptions turned out to be flawed (also missed by the rating agencies) but many investors didn’t perform their due diligence and ignored risk. They wanted those extra basis points and then levered up on a sure thing. Banks and investors also ignored the reason that you don’t buy illiquid assets with short term debt (SIV’s and ABCP). Common sense failed to strike the many professional participants as you see very few big commercial and investment banks that were relatively untouched by this. Some of the prior high leveraged lending transactions to private equity, etc, also came back to haunt lenders that ignored the credit basics.