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Does the Financial Crisis Discredit Libertarianism?

Writing in Slate, Jacob Weisberg claims that the financial crisis discredits libertarianism:

A source of mild entertainment amid the financial carnage has been watching libertarians scurrying to explain how the global financial crisis is the result of too much government intervention rather than too little....

[T]o summarize, the libertarian apologetics fall wildly short of providing any convincing explanation for what went wrong. The argument as a whole is reminiscent of wearying dorm-room debates that took place circa 1989 about whether the fall of the Soviet bloc demonstrated the failure of communism. Academic Marxists were never going to be convinced that anything that happened in the real world could invalidate their belief system. Utopians of the right, libertarians are just as convinced that their ideas have yet to be tried, and that they would work beautifully if we could only just have a do-over of human history...

To which the rest of us can only respond, Haven't you people done enough harm already? We have narrowly avoided a global depression and are mercifully pointed toward merely the worst recession in a long while. This is thanks to a global economic meltdown made possible by libertarian ideas.

There are several problems with Weisberg's thesis. First, the US had hardly been following free market financial policies in the years prior to the crisis. Many commentators have pointed out the central role of government sponsored enterprises (GSEs) such as Fannie and Freddie Mac in promoting subprime and other risky mortgages that investors were willing to acquire in part because they believed that the GSEs would be backed by a government bailout if anything went badly wrong. As the term "government-sponsored" implies, Fannie and Freddie were hardly free market institutions. Some libertarian-leaning scholars, such as Peter Wallison in this 2005 article, have long predicted that their policies could lead to catastrophe unless reined in. The crisis was also fueled by the Federal Reserve Board's promotion of artificially easy credit over the first half of this decade. To put it mildly, libertarians have never liked the Fed. They have have often emphasized, as I did in this April post, that it is dangerous to give a small group of government technocrats vast power over the economy.

Recent American economic policy has not been especially pro-market in areas outside finance regulation either. During his first five years in office, George W. Bush presided over the biggest expansion of government spending in decades, including a major increase in regulatory spending.

Second, even if one can say that the US was following market-based policies in recent years, the same can't be said of European nations such as Germany, Iceland, and Spain, all of which have had mortgage/financial crises at least as severe as ours. If the financial crisis discredits "libertarianism" in the US, does it also discredit German social democracy? In my view, neither is true. But Weisberg's logic points in that direction.

Finally, no ideology can be judged solely by its performance in one particular crisis. Any set of policies is imperfect and therefore may provide flawed answers in a particular situation. Here is where Weisberg's analogy with communism circa 1989 breaks down. The problem with communism was not that communists had handled some one isolated crisis poorly. It is that communism's overall record over many decades was one of repression, mass murder, and economic decline - all with few or no offsetting benefits. Economic liberalization over the last several decades, by contrast, has lifted millions out of poverty around the world and greatly increased both personal freedom and standards of living. As Gary Becker points out, the period of economic liberalization in the twenty years or so prior to Bush's "big government conservatism" saw enormous economic gains. He suggests that if today's crisis were indeed an inevitable result of that liberalization, the overall balance sheet (25 years of massive progress vs. 2-3 years of painful recession) might be worth it.

It would be foolish to completely dismiss the possibility that libertarians were overly optimistic about the virtues of unregulated financial markets. It may turn out that some new forms of finance regulation will be justified. I do not believe that libertarian thought is perfect; far from it in fact. I merely think it is better than the available alternatives.

Be that as it may, libertarianism, like other ideologies, must be judged by its overall record. And that record must be compared to the overall record of the alternatives. For example, even if new regulation is indeed needed, we must be sensitive to the danger that crises such as this one present tempting opportunities for governments to expand their power in harmful ways that go far beyond what is necessary to address the crisis itself.

Weisberg is right to predict that libertarian ideas will face an uphill political struggle over the next few years. After Obama wins, government will almost certainly expand considerably, helped by a combination of united Democratic government and a crisis atmosphere. Even if McCain somehow manages to pull out the election, things won't look too good for free market ideas. Economic crises often provide a strong impetus for government intervention and the ideologies that advocate it. I'm not convinced, however, that free market advocates will be permanently defeated. Still less do I believe that they deserve to be.

UPDATE: Matt Welch has a good response to Weisberg's piece here.

DavidBernstein (mail):
Great post, Ilya! If anything, the crisis should discredit central planning of the market for money (state-controlled central banks).

The fact that there was a housing/credit bubble not just in the U.S., but England, Australia, Germany, Spain, Hong Kong, Beijing, etc., makes it pretty plain that the underlying root of the crisis was not any country's specific fiscal or regulatory policies (though some made it worse), but the worldwide central-bank dictated credit easing that started in 1998 and continued with new vigor after the dot com bust and 9/11.

I'd love to see Wiesberg explain how libertarianism is to blame for the housing bubble in London under the British Labor government.
10.20.2008 8:19pm
Ilya Somin:
Thanks, David, and good point.
10.20.2008 8:25pm
Charlie (Colorado) (mail):
Because, after all, what could be more conclusive as an indictment of libertarianism than a market crisis induced by a massive 30 year market intervention, compounded by hundreds of millions of dollars spent on lobbying by a government sponsored company to conceal the fact that they were committing massive fraud?
10.20.2008 8:30pm
Brett:
I kind of like the part at the beginning where Weisberg cavalierly dismisses the notion that regulations rewarding lenders for, or requiring them to, extend mortgages to uncreditworthy borrowers had something important to do with the crisis. I always appreciate it when writers signal that a particular piece is actually comedy.
10.20.2008 8:30pm
rfg:
1) Brett- I've never been able to find the part of the Coomunity Reinvestment Act that required or encouraged lenders to approve loans that could not be paid back. Could you help?
2)David Bernstein- Could it also be that banks in these countries went for the quick buck of mortgage-backed securities, derivative swaps, etc?

The current dilemma was not born overnight, nor was it cused by any one regulation(or even several regulations). A number of things combined to create this mess, and it's going to take some time to sort the wheat from the chaff here.

Some days I wonder if the current mania with short-term profits (as exemplified by a fixation with stock prices) isn't one of the root causes?

Mr Wlch is entirely correct in one thing- regulation encourages gaming the system- complex regulation even more so. It is possible (as an ideal, perhaps) to have an optimim level of regulation- why don'twe aim for that?
10.20.2008 8:45pm
Dr. T (mail) (www):
We have a bizarre government that is part representative democracy, part socialism, and part fascism (with the latter two continually acquiring bigger proportions).

We have a bizarre economic system is part capitalism, part corporatism, and part bureaucratism (with the latter two continually acquiring bigger proportions).

When such unwieldy amalgamations fail, how does this reflect badly on libertarianism (which is nowhere in the mix)?

Weisberg reaches that conclusion after making the following fallacious argument:

1. The economy failed due to inadequate regulations.
2. Libertarians prefer minimal regulations.
3. A libertarian society would fail economically.

But, statement 1 is not proved, so his argument fails.
10.20.2008 8:50pm
Brett:
Uh, rfg, the whole point of the CRA was to pressure banks into making loans with one eye on financial risk and the other on the "common good" goal of putting lower-income citizens into homes. Regrettably lower-income citizens are frequently lousy credit risks.

Combine that with HUD mandates for Fannie and Freddie to issue huge percentages of their available mortgage financing to borrowers with incomes at or below the median in their area. Fannie and Freddie met these mandates with large numbers of subprime and APR loans, which remained affordable for these borrowers only so long as property values continued to appreciate.

But if Weisberg is to be believed, this is all a scathing critique of libertarianism.
10.20.2008 9:10pm
SSFC (www):
Whoever is elected, his solution to the financial crisis is going to restore all of the lost credit to libertarianism, and then some.
10.20.2008 9:13pm
Dilan Esper (mail) (www):
Great post, Ilya! If anything, the crisis should discredit central planning of the market for money (state-controlled central banks).

Come back and talk to us when libertarian discovers a way to do countercyclical monetary policy without a central bank.

Seriously, Weisberg's article is clearly over the top-- the causes of the current crisis are complicated and undoubtedly the libertarians have a point about Fannie and Freddie (although Weisberg also has a point about the need for regulation of complex financial instruments).

But no, the reason why you need to have an independent central bank is because without it, you take away just about the only effective tool at smoothing out the business cycle (in theory, running deficits and surpluses could also help, but in practice political decisionmakers don't do this right and aren't able to time it correctly even when they do the right thing).

By the way, there is an open question as to whether the Fed is the proper place to repose REGULATORY authority over various aspects of the financial system which had a role in causing the crisis. But far from proving why we don't need a Fed, we need the Fed's core function more than ever right now, because close supervision of monetary policy is going to be essential to the recovery.
10.20.2008 9:28pm
Duncan C. Coffee (mail):
I myself have never met a libertarian who support the weird, half-monetarist, half-Keynesian thing, and I certainly don't know anyone who support applying political correctness and affirmative action to home loans. So I'm pretty skeptical of claims the Diversity Depression will discredit libertarians. But you make the case better, Ilya Somin.
10.20.2008 9:37pm
Frater Plotter:
(in theory, running deficits and surpluses could also help, but in practice political decisionmakers don't do this right and aren't able to time it correctly even when they do the right thing).

What makes you think that central bankers have the magical ability to "time it correctly" that politicians lack? I suggest that neither group have this ability.
10.20.2008 9:47pm
the emperor (www):
But no, the reason why you need to have an independent central bank is because without it, you take away just about the only effective tool at smoothing out the business cycle

I've never understood what's so important about "smoothing out the business cycle." Yes, you can do that, and in the process reduce total economic welfare. But why would you want to?
10.20.2008 10:06pm
Obvious (mail):
Ilya: "There are several problems with Weisberg's thesis."

As it happens, that's a macro on my word processor...
10.20.2008 10:09pm
Assistant Village Idiot (mail) (www):
Weisberg's analysis is rather thin on evidence, thick on sneering. Better suited for HuffPo.
10.20.2008 10:26pm
Duncan C. Coffee (mail):
"I've never understood what's so important about "smoothing out the business cycle." Yes, you can do that.... But why would you want to?" - the emperor

I think a big part of Keynes' thesis was that the bottom parts of the business cycle are just too depressing. Psychological effects will cause people to violently revolt, which will cause factory equipment, etc., to be destroyed, making it hard to climb the good part of the cycle. A lot of people were convinced by this thesis. I was. Not so sure any more.
10.20.2008 10:57pm
David C. (www):
oh, quit pouting
10.20.2008 11:22pm
big bob (mail):
There seems to be a good correlation between industries which are most heavily regulated and those that routinely run into "crisis." I wonder why that is?
10.20.2008 11:31pm
Dilan Esper (mail) (www):
I myself have never met a libertarian who support the weird, half-monetarist, half-Keynesian thing, and I certainly don't know anyone who support applying political correctness and affirmative action to home loans. So I'm pretty skeptical of claims the Diversity Depression will discredit libertarians. But you make the case better, Ilya Somin.

Anyone who believes that the main or central cause of this scandal is "affirmative action", "political correctness", or "diversity" is just applying a preexisting hatred of minorities to the current situation.

Not to say that too many subprime loans weren't given out, but there were plenty of market forces-- not just the CRA and the GSE's-- that led to this. (Essentially, it is short-term rational to give out teaser mortgages to people who ostensibly won't be able to pay them off during a housing boom, because you can always refinance the loans and pay the bank off.)

What makes you think that central bankers have the magical ability to "time it correctly" that politicians lack?

Because we have decades of evidence that they do it pretty well (so long as they are powerful and insulated from political branches of government), and we have centuries of evidence before then that show other approaches not working and deeper, longer recessions.

I've never understood what's so important about "smoothing out the business cycle." Yes, you can do that, and in the process reduce total economic welfare. But why would you want to?

Because the alternative is long, deep recessions with bread lines and soup kitchens.

And your claim that total economic welfare is better if you don't smooth out the business cycle is a strange one. First, there really isn't any evidence for it. Second, big-time recessions not only screw the poor and middle class (which are actually more important than total economic welfare, unless you are willing to redistribute the wealth ex post), but definitely reduce total economic welfare.

I think a big part of Keynes' thesis was that the bottom parts of the business cycle are just too depressing. Psychological effects will cause people to violently revolt, which will cause factory equipment, etc., to be destroyed, making it hard to climb the good part of the cycle. A lot of people were convinced by this thesis. I was. Not so sure any more.

It's true. But beyond that, even if you aren't convinced by it, the simple human hardship caused by a recession is reason enough to avoid them. Again, you can't treat millions of people as expendable in this way-- even if you can grow the pie in the long term and you won't have a Keynesian revolt, there's still good reason to try to avoid deep recessions just because of the hardship they cause.

There seems to be a good correlation between industries which are most heavily regulated and those that routinely run into "crisis." I wonder why that is?

Without a citation to any sort of authority, you have no warrant to say this. In any event, Weisberg is correct-- the crucial securities in the current mess were UNDERregulated. You will notice that more regulated instruments-- such as stocks, bank deposits, and bonds-- were not where the problem was.
10.21.2008 12:08am
Ariel:
Early in the article, he essentially writes:

1) Libertarians have some arguments (Fannie, CRA, etc.)
2) There are rebuttals to those arguments (but he will not mention them)
3) There are rejoinders to those rebuttals (but he will not mention them)

By my logic, Libertarians win on the un-rebutted #1, or #3 trumping #2. But heck, I'm just trying a little bit of basic logic here.
10.21.2008 12:14am
DavidBernstein (mail):
Dilan, I'm not going to argue that central banks are worse than the alternative. But I will argue that if the point Weisberg is making is that whatever caused this crisis should be discredited, than the most logical candidate is state-run central banks.
10.21.2008 1:07am
DavidBernstein (mail):
P.S. It was obvious to some of us DURING the bubble that Greenspan was making a huge error in treating inflation as purely a consumer price phenomenon, and ignoring the inflation in real estate as if asset price inflation beyond any historical precedent is not inflation.
10.21.2008 1:09am
SenatorX (mail):
Essentially, it is short-term rational to give out teaser mortgages to people who ostensibly won't be able to pay them off during a housing boom, because you can always refinance the loans and pay the bank off

Oh please, Banks didn't suddenly wake up and realize they could get people to refinance and pay off the loans. That doesn't even make sense. People don't refinance to pay off the loans, the refinance to lower their interest rates or to take equity out gained by ponzi appreciation. The banks started making risky loans because the RISK was taken away due to the ability to sell the loans on the secondary mortgage market. The secondary mortgage market is Fannie and Freddie. Those money laundering operations which could then repackage the MBS and get buyers at decent rates due to the implicit government guarantee. This kept mortgage rates low and help re-enforce the boom. You can blame "market forces" all you want but the incentive was created by the government's intervention and maintained by the fig leaf of helping the poor own homes.
10.21.2008 1:45am
American Psikhushka (mail):
Dilan Esper-

Come back and talk to us when libertarian discovers a way to do countercyclical monetary policy without a central bank.

They (Austro-libertarians, that is) already have.

A central bank with a fiat currency and interventionist policies tends to exacerbate and to some extent create boom-bust or, perhaps more accurately, bubble-bust cycles. (Since the inflation of fiat currencies tends to cause asset bubbles, malinvestment, etc.) When you have a hard currency backed by gold or a similar standard and no central bank (therefore no interventionism) the normal business cycle is less extreme because inflationary policies are not causing the associated asset bubbles, malinvestment, etc.

But no, the reason why you need to have an independent central bank is because without it, you take away just about the only effective tool at smoothing out the business cycle

Ah, so you need a central bank using a fiat currency and interventionist policies to smooth out the bubble-bust cycles caused by - a fiat currency and interventionist policies. I'm reminded of the Shining: All work and no play makes Jack a dull boy. All work and no play makes Jack a dull boy.......

Not to say that too many subprime loans weren't given out, but there were plenty of market forces-- not just the CRA and the GSE's-- that led to this.

Well one of the main causes, if not the main cause, was not a "market force" - at least not a free market force - at all. It was the cheap credit provided by: a central bank (that shall remain nameless) using a fiat currency and interventionist policies. That dumped gasoline on the fire the CRA and the GSE's started.

And note this is more bubble-bust cycling. Even some mainstream Keynesians and the like surmise that assets from the tech stock bubble were shifted into the real estate bubble.

Because we have decades of evidence that they do it pretty well (so long as they are powerful and insulated from political branches of government), and we have centuries of evidence before then that show other approaches not working and deeper, longer recessions.

I don't know about that. We also have multiple examples of central banks destroying their economies by hyperinflating their currencies while trying to print and spend their way out of financial crises. These crises were usually caused by a fiat currency and interventionist policies in the first place.

And your claim that total economic welfare is better if you don't smooth out the business cycle is a strange one. First, there really isn't any evidence for it. Second, big-time recessions not only screw the poor and middle class (which are actually more important than total economic welfare, unless you are willing to redistribute the wealth ex post), but definitely reduce total economic welfare.

Well the solution is not to exacerbate the business cycle and turn it into a bubble-bust cycle in the first place.

And regarding the poor and middle class: There are few policies that screw over the poor and the middle class more than inflation does. It's a hidden tax that robs them of whatever real spending power they've managed to earn while at the same time creating the violent bubble-bust cycles. Robbed through inflation whether times are good or bad, often put out of work by the inflation when the bubbles bust.

It's true. But beyond that, even if you aren't convinced by it, the simple human hardship caused by a recession is reason enough to avoid them. Again, you can't treat millions of people as expendable in this way-- even if you can grow the pie in the long term and you won't have a Keynesian revolt, there's still good reason to try to avoid deep recessions just because of the hardship they cause.

Except that the recessions are exacerbated and to an extent caused by Keynesian interventionist policies in the first place.

Without a citation to any sort of authority, you have no warrant to say this. In any event, Weisberg is correct-- the crucial securities in the current mess were UNDERregulated. You will notice that more regulated instruments-- such as stocks, bank deposits, and bonds-- were not where the problem was.

Not at all. If the banks weren't induced (through regulation and policy) to make all these bad, nearly certain to fail loans in the first place they wouldn't have been searching to create these securities that supposedly "financially engineered" away the unavoidable risks, eventually leaving the public as the bagholders. If the banks were left to their own devices they would have been doing what they're supposed to do - sticking to loans that make sense because they are likely to be paid back.

This is the classic case of a regulation or intervention causing problems and then those performing the regulation or intervention claiming that the solution lies in allowing them to make more regulations and interventions.
10.21.2008 1:49am
SenatorX (mail):
Anyone who believes that the main or central cause of this scandal is "affirmative action", "political correctness", or "diversity" is just applying a preexisting hatred of minorities to the current situation.

Poisoning the Well is one of the fallacies. Weak sauce and deserves no traction.

As for Central Banks getting it right due to their superior predictive power not even they are arrogant enough to say that. In fact they admit all the time to getting it wrong. They overshoot EVERY TIME in both directions. It is impossible for them not to, due to the impossibility of the task. They deal with lagging indicators, guess work, and market expectations. Of course they only admit to these mistakes years after the events. When the crisis are going on they must play daddy at the wheel.

DB I am not sure exactly which alternative is worse than Central Banking but I assume you probably mean the gold standard. I think we should be careful not to assume we have to get rid of the fiat system if we get rid of central banks. We could keep fiat and fix fractional reserve lending as well as find a market mechanism for setting interest rates. Something based on feedback loops. I don't claim to have a system designed but ANYTHING would be better than a group of people deciding what the price of money should be. They are both fallible and subject to influence. There is no committee that has ever been in existence that wasn't influenced by someone or something, to think otherwise is to fantasize(looking @Dilan).

I thought this was a great post by Ilya and as hard as the next decade is going to be we are all well served by having people like him arguing for the libertarian perspective.
10.21.2008 2:09am
SenatorX (mail):
Ahh the American Psikhushka! Perhaps my favorite libertarian commenter at this site. There is much work for you here these days. It seems like one of the main problems of people arguing against libertarianism is they just don't get what it even is. Maybe they don't want to get it. I read this article today and it made my brain hurt.

Some gems about his new book : "What I mean by the new barbarism is great ideas having bad effects. Great ideals turning out to be the stem cell of big crimes, big injustices, unfairnesses, brutality and so on." I am really glad he found this "new barbarism".

Or this!:

"SALON: If there were three main differences between the left and the right, right now, what would you say they are?

LEVI: To believe or not to believe that equality and freedom can be combined, as I told you, is one difference. (Another is) to believe or not to believe in politics. A classical rightist or leftist-rightist does not believe in politics; he believes in the invisible hand of the market in one case, of history in the other case -- the invisible hand being able, herself and alone, to promote the change and the reform and so on. For me, a leftist is somebody who believes a democracy has to be built with time, patience, real meaning and so on."

I will start to take these people more seriously when they can actually represent the libertarian viewpoint with some degree of accuracy. Instead it's always with the straw men. Could this "philosopher" have never read Hayek?
10.21.2008 2:33am
Mahan Atma (mail):
Fannie and Freddie had well under half the subprime loan market. The rest was taken up by purely private entities.

Nobody forced those entities to do anything. They got into the market for one reason only: They were making buckets and buckets of money.

Furthermore, Fannie and Freddie didn't make the loan originators engage in fraud, or offer loans to anyone who could fog a mirror. Those entities did it because they were making buckets of money.

Nor did Fannie and Freddie create the (unregulated) sixty trillion dollar Credit Default Swap market which now threatens to bring down AIG and other enormous, purely private entities.

Nor were Fannie and Freddie responsible for rating the mortgage-backed securities. That was done by purely private entities who had blatant conflicts of interest.

The Republicans' single-minded focus on Fannie/Freddie is telling. Fannie/Freddie were part of the problem, but to describe them as "central" or somehow the root cause of the crisis is highly misleading.
10.21.2008 2:35am
ichthyophagous (mail):
I say the real point is that a society that does not require human trustworthiness is headed for problems. Default insurance just doesn't cut it.
10.21.2008 8:57am
merevaudevillian:
John Stossel had a fantastic special, "Politically Incorrect Guide to Politics," last Friday. His video on the housing market is here. He indicts TOO MUCH regulation, not a lack of it. It's well-worth a view.
10.21.2008 9:00am
SenatorX (mail):
Fannie and Freddie had well under half the subprime loan market. The rest was taken up by purely private entities.

Are you counting subprime sold to Fannie and Freddie and then repackaged and bought by private investors?

Nobody forced those entities to do anything. They got into the market for one reason only: They were making buckets and buckets of money.

That isn't the point at all. Are you saying people trying to make money is bad? The point has to do with government intervention that created a structure where the incentives were to make risky loans.

They actually were forced to make subprime loans though. That's what the CRA was. A system where they were rated on a point system by how many subprime loans they made and if they didn't make enough they were penalized by the government. I don't think this was the whole driver of the problem but you can't say it didn't exist when it clearly did.

Furthermore, Fannie and Freddie didn't make the loan originators engage in fraud, or offer loans to anyone who could fog a mirror. Those entities did it because they were making buckets of money.

No they made the loans to anyone because they made buckets of money AND were able to pass the risk on by re-selling the loans, thanks to Fannie and Freddie.

Nor did Fannie and Freddie create the (unregulated) sixty trillion dollar Credit Default Swap market which now threatens to bring down AIG and other enormous, purely private entities.

Separate problem but I wouldn't argue this one with you really, at least not as a Fannie/Freddie problem. The CDS value is actual probably half that number btw because of so many duplicates. One of the main problems here was a LACK of a market to act as a clearing house. That is coming soon. The FIX is a market. Not many libertarians btw would claim the government or regulation has no role in creating markets. That is just a straw man used by anti-free marketers to bash a position that hardly exists.

Nor were Fannie and Freddie responsible for rating the mortgage-backed securities. That was done by purely private entities who had blatant conflicts of interest.

That is partly true. The fig leaf that allowed the rating agencies to mis-rate many of the securities was the implicit government guarantee on the Fannie and Freddie debt. They would actually sprinkle some GSEs dept into the MBS to gain this. A whole lot of subprime and a little bit of GSE and voila, AAA. I would agree the conflict of interest (pay to play)was an additional part of the problem though.

The Republicans' single-minded focus on Fannie/Freddie is telling. Fannie/Freddie were part of the problem, but to describe them as "central" or somehow the root cause of the crisis is highly misleading.

The argument here isn't a Republican one though. I've never voted Republican in my life. It's a question of the libertarian view of minimal government intervention and if the "free market" caused all the problems, followed by should more government intervention fix all the problems.
10.21.2008 10:44am
Adam J:
Maybe it's just me, but why isn't anyone mentioning the ludicrious credit ratings these banks had? These banks were leveraged 20-1 or more and yet were rated AAA- that's completely insane (disaster struck when rating agencies and creditors realized the banks assets weren't as valuable as they originally thought and essentially issued a margin call). To me the biggest problem was pretty clearly this, no organization leveraged that much can be a safe investment, yet everyone thought they were. And the rating system is completely bizarre, the higher your credit rating the more money you are allowed to borrow... thus making the highest rated institutions the least stable. t's really impossible to see whether libertarianism would be effective through the morass of various causes... I personally think this problem is essentially a market failure, banks sank themselves by borrowing way too much money &making a bad bet with the money. No regulations (that I'm aware of) obligated them to borrow so much or obligated lenders to lend them money. Of course, a host of non-market factors probably exacerbated the problem, making it impossible to tell if this would have been less serious without regulation.
10.21.2008 11:46am
Mahan Atma (mail):
"Are you counting subprime sold to Fannie and Freddie and then repackaged and bought by private investors?"


Yes. I'm talking about all subprime loans purchased from the originators by the secondary mortgage market:

"In 2004, they [Fannie and Freddie] purchased $175 billion -- 44 percent of the market. In 2005, they bought $169 billion, or 33 percent. In 2006, they cut back to $90 billion, or 20 percent."

Source.

So Fannie and Freddie never even had most of the market. 55-80% of the loans were bought by purely private entities.

"The point has to do with government intervention that created a structure where the incentives were to make risky loans."


What "structure" were the purely private entities working under? None. If Fannie/Freddie hadn't existed at all, the private entities still would have been in the business; they simply would have had 100% of the market instead of 55-80% of it.

This is why it's wrong to identify Fannie/Freddie as the "cause" or "central" to the crisis.
10.21.2008 11:56am
Mahan Atma (mail):
"No they made the loans to anyone because they made buckets of money AND were able to pass the risk on by re-selling the loans, thanks to Fannie and Freddie."


If Ford starts pumping out defective trucks, but still makes buckets of money because Acme Shipping buys them all up, who should get most of the blame?
10.21.2008 12:01pm
Mahan Atma (mail):
"They actually were forced to make subprime loans though. That's what the CRA was. A system where they were rated on a point system by how many subprime loans they made and if they didn't make enough they were penalized by the government. I don't think this was the whole driver of the problem but you can't say it didn't exist when it clearly did."


No, the CRA did NOT force lenders to make loans to people who were not creditworthy. Nor did the CRA force lenders or borrowers to engage in mortgage fraud.

It is also patently silly to say the lenders were "forced" to do something that was making them buckets of money. "Twist my arm", they must have said.

From Barry Ritholtz:

• Did the 1977 legislation, or any other legislation since, require banks to not verify income or payment history of mortgage applicants?

• 50% of subprime loans were made by mortgage service companies not subject comprehensive federal supervision; another 30% were made by banks or thrifts which are not subject to routine supervision or examinations. How was this caused by either CRA or GSEs ?

• What about "No Money Down" Mortgages (0% down payments) ? Were they required by the CRA? Fannie? Freddie?

• Explain the shift in Loan to value from 80% to 120%: What was it in the Act that changed this traditional lending requirement?

• Did any Federal legislation require real estate agents and mortgage writers to use the same corrupt appraisers again and again? How did they manage to always come in at exactly the purchase price, no matter what?

• Did the CRA require banks to develop automated underwriting (AU) systems that emphasized speed rather than accuracy in order to process the greatest number of mortgage apps as quickly as possible?

• How exactly did legislation force Moody's, S&Ps and Fitch to rate junk paper as Triple AAA?

• What about piggy back loans? Were banks required by Congress to lend the first mortgage and do a HELOC for the down payment -- at the same time?

• Internal bank memos showed employees how to cheat the system to get poor mortgages prospects approved that shouldn't have been: Titled How to Get an "Iffy" loan approved at JPM Chase. (Was circulating that memo also a FNM/FRE/CRA requirement?)

• The four biggest problem areas for housing (by price decreases) are: Phoenix, Arizona; Las Vegas, Nevada; Miami, Florida, and San Diego, California. Explain exactly how these affluent, non-minority regions were impacted by the Community Reinvesment Act ?

• Did the GSEs require banks to not check credit scores? Assets? Income?

• What was it about the CRA or GSEs that mandated fund managers load up on an investment product that was hard to value, thinly traded, and poorly understood

• What was it in the Act that forced banks to make "interest only" loans? Were "Neg Am loans" also part of the legislative requirements also?

• Consider this February 2003 speech by Countrywide CEO Angelo Mozlilo at the American Bankers National Real Estate Conference. He advocated zero down payment mortgages -- was that a CRA requirement too, or just a grab for more market share, and bad banking?

The answer to all of the above questions is no, none, and nothing at all.
10.21.2008 12:08pm
Mahan Atma (mail):
Community Reinvestment Act had nothing to do with subprime crisis

The Community Reinvestment Act, passed in 1977, requires banks to lend in the low-income neighborhoods where they take deposits. Just the idea that a lending crisis created from 2004 to 2007 was caused by a 1977 law is silly. But it's even more ridiculous when you consider that most subprime loans were made by firms that aren't subject to the CRA. University of Michigan law professor Michael Barr testified back in February before the House Committee on Financial Services that 50% of subprime loans were made by mortgage service companies not subject comprehensive federal supervision and another 30% were made by affiliates of banks or thrifts which are not subject to routine supervision or examinations. As former Fed Governor Ned Gramlich said in an August, 2007, speech shortly before he passed away: "In the subprime market where we badly need supervision, a majority of loans are made with very little supervision. It is like a city with a murder law, but no cops on the beat."
10.21.2008 12:12pm
one of many:
Mahan Atma,

The WP article is talking about mortgage backed securities (sold by Fannie and Freddie) and the market for those securities not the mortgages themselves and the market for mortgages. F &F were in an interesting game of buyin individual mortgages, bundling them into securities and then selling them on the market with F &F being their own biggest customers for the securities.
10.21.2008 12:20pm
Mahan Atma (mail):
Regardless of whether the loans were bought directly from the originators or in packaged form, Fannie and Freddie still had less than half the market in the end. What difference does it make if the loans are packaged? They're still toxic, and purely private entities bought the majority of them.
10.21.2008 12:34pm
Michael F. Martin (mail) (www):
Both Weisberg and Somin go to far in equating libertarianism with laissez-faire.
10.21.2008 12:39pm
wyswyg:
Why do I suspect that if Fannie and Freddie had been liberally staffed with Republicans rather than Democrats, Mahan Atma would be a lot less eager to downpaly their role here? I guess I'm just a cynic.

"Consider this February 2003 speech by Countrywide CEO Angelo Mozlilo at the American Bankers National Real Estate Conference. He advocated zero down payment mortgages -- was that a CRA requirement too, or just a grab for more market share, and bad banking? "




You might want to do a little research, real research, into Angelo. For instance:


In the week since the Journal revealed this ["Friends of Angelo"] program, the key questions have become clear: What did Countrywide CEO Angelo Mozilo receive -- or think he would receive -- in return for the friendly loans to politicians? And what did Mr. Mozilo get -- or think he would get -- in return for sweetheart loans to Fannie Mae CEOs Jim Johnson and Franklin Raines? [Sen. Kent] Conrad says he called Mr. Mozilo at the suggestion of Mr. Johnson, a leading and long-time member of the Democratic Beltway establishment.

The relationship between Countrywide and Fannie Mae goes to the heart of the mortgage crisis. Fannie makes its money by borrowing vast sums at low rates (thanks to an implied taxpayer guarantee on its loans) and then using that cash to buy loans from mortgage originators like Countrywide. Fannie then holds the mortgages and earns interest on them, or pools them into securities for sale to investors.

Fannie has been buying more home loans from Countrywide than from anyone else. In its most recent 10-K report filed with the Securities and Exchange Commission in February, the company reports: "Our top customer, Countrywide Financial Corporation (through its subsidiaries), accounted for approximately 28% of our single-family business volume in 2007, compared with 26% in 2006."

A Fannie spokesman tell us that "for competitive and proprietary reasons, we can't provide information about the terms we agree to with specific lenders," and adds, "We don't have lender-specific performance data available." Count us among the skeptics that Fannie hasn't bothered to check how well Countrywide's loans perform compared to those of other lenders vying to do business with the government-sponsored giant. But then again, we don't know what terms Countrywide's competitors offer on loans to Fannie CEOs.





You might also look into the sweetheart deals Angelo gave to many people in Congress charged with oversight.

At least, you might do these things if the party affiliations involved were different.
10.21.2008 12:51pm
one of many:
But only after Fannie and Freddie were involved and in theory stripped them of their toxicity by securitizing them. IF Fannie and Freddie had somehow managed to buy 100% of the securities F&F wrote there would be no widespread financial crisis because the only exposure to the effects of F&F's policies would be to F&F, however the federal cost would be enourmous since F&F used securities issued and owned by themselves as collateral to borrow money from the Fed to buy mortgages with.

I suppose if F&F sold fewer mortgage backed securities (wasn't able to buy them itself for instance and was 0% of the market for the securities) then it would have had less money to invest in buying mortgages so there would have been fewer sub-prime loans bought by F&F, but this is speculative and contrary to what you appear to be arguing.
10.21.2008 12:54pm
wyswyg:
"Fannie and Freddie still had less than half the market in the end."




There you go! Obama cronies like Jim Johnson were responsible for less than half the toxic loans!

And you actually regard that as a defense.
10.21.2008 12:55pm
wyswyg:
More pesky facts.


Former Lehman Brothers CEO Dick Fuld was under oath Monday when he was grilled on Capitol Hill about his role in the current financial meltdown. But if Members really want to understand the credit mania, they should also call Chris Dodd.

Former Countrywide Financial loan officer Robert Feinberg says Mr. Dodd knowingly saved thousands of dollars on his refinancing of two properties in 2003 as part of a special program the California mortgage company had for the influential. He also says he has internal company documents that prove Mr. Dodd knew he was getting preferential treatment as a friend of Angelo Mozilo, Countrywide's then-CEO.

That a "Friends of Angelo" program existed is not in dispute. It was crucial to the boom that Countrywide enjoyed before its fortunes turned. While most of the company was aggressively lending to risky borrowers and off-loading those mortgages in bulk to Fannie Mae and Freddie Mac, Mr. Feinberg's department was charged with making sure those who could influence Fannie and Freddie's appetite for risk were sufficiently buttered up. As a Banking Committee bigshot, Mr. Dodd was perfectly placed to be buttered.



10.21.2008 1:03pm
wyswyg:
Even the NYT is catching on to Dodd.

After reports emerged in June about him having received favorable treatment on two home mortgages from the Countrywide Financial Corporation, Senator Christopher Dodd, a Democrat from Connecticut, promised that he would release documents to support his contention that he never benefited financially from the terms of the loans.

The senator has failed to keep his promise, and his excuses are wearing ridiculously thin.

"I think it will become obvious at the time when it's the right time, and I'll explain that at the time when I do so," Mr. Dodd said last week after a speech in Norwich, Conn., according to The Hartford Courant.

When asked to elaborate, he said: "My answer is what it is, and in the right time, it will be there."






Change you can believe in, or something.
10.21.2008 1:12pm
Mahan Atma (mail):
"There you go! Obama cronies like Jim Johnson were responsible for less than half the toxic loans!

And you actually regard that as a defense."


First of all, I did not say they were "responsible" for them -- I think the loan originators are most "responsible" for making bad loans.

Secondly, I'm not arguing that Fannie/Freddie were completely blameless. I'm saying they were only one part of the system, and were NOT the cause of it.
10.21.2008 1:17pm
wyswyg:
"I think the loan originators are most "responsible" for making bad loans."





Loan originators like, for instance, Angelo Mozilo?
10.21.2008 1:19pm
Mahan Atma (mail):
"Obama cronies like Jim Johnson"


Show me evidence that Jim Johnson and Obama were "cronies".

You're aware, aren't you, that McCain's campaign manager Rick Davis lobbied for Fannie and Freddie, and the head of his transition team, William Timmons, lobbied for Freddie?
10.21.2008 1:20pm
Mahan Atma (mail):
"Loan originators like, for instance, Angelo Mozilo?"


Yes, absolutely.

And no, I don't like Dodd either.
10.21.2008 1:21pm
wyswyg:
"I'm saying they were only one part of the system, and were NOT the cause of it."




F+F were/are a lobby to rival the AARP. Stop pretending that they were/are this passive and inert body being victimized by those wicked "loan originators". F+F were/are in bed with their supposed Congressional watchdogs, and also with those wicked "loan originators". In fact F+F were the tail that wagged the Congressional dog.
10.21.2008 1:25pm
Mahan Atma (mail):
"Stop pretending that they were/are this passive and inert body being victimized by those wicked "loan originators"."


You're arguing with straw men. I never said they were "passive and inert".
10.21.2008 1:29pm
wyswyg:
"Yes, absolutely."




Have you read the things I've posted? Angelo had a very cozy relationship with Jim Johnson. Which was why
"Fannie has been buying more home loans from Countrywide than from anyone else".

The wall of separation which you're been trying to create between F+F and the Congressional Democrats on the one hand, and those evil "loan originators" on the other, was non-existent. Everyone was in bed with everyone else.
10.21.2008 1:31pm
Mahan Atma (mail):
Again, you are trying to attribute to me an argument I am not making.

I am not trying to create a "wall of separation" between Fannie/Freddie and Congressional Democrats.

I am disputing the claims that somehow Fannie and Freddie are the primary causes of the crisis.
10.21.2008 1:36pm
wyswyg:
You're arguing with straw men. I never said they were "passive and inert".




Are you a straw man?

You may not have used the words "passive and inert" but your entire spiel here has been to cast the blame on the loan originators, who you no doubt imagine are all free market libertarians. In your telling, they are responsible for selling bad loans to hapless Fannie.

Show me evidence that Jim Johnson and Obama were "cronies".



Grow up.


"You're aware, aren't you, that McCain's campaign manager Rick Davis lobbied for Fannie and Freddie"




You're aware, aren't you, that Davis is now working for a man, McCain, who was an opponent of F+F?

Unlike, you know, Obama. Who exemplifies the type of politician who is in bed with crooked businessmen.
10.21.2008 1:38pm
Mahan Atma (mail):
"but your entire spiel here has been to cast the blame on the loan originators"


No, I mentioned quite a few other blameworthy players: Credit agencies, the private entities who purchased MOST OF the mortgage securities, fraudulent borrowers, and you can add the Fed to that list as well.

You don't want to argue with what I've actually said, so I'm not going to waste my time arguing with you. Later.
10.21.2008 1:42pm
wyswyg:
"I am not trying to create a "wall of separation" between Fannie/Freddie and Congressional Democrats. "





Your reading comprehension is shockingly bad. What I said was;


"The wall of separation which you're been trying to create between F+F and the Congressional Democrats on the one hand, and those evil "loan originators" on the other ..."



Let me know if you still don't see the difference.


"I am disputing the claims that somehow Fannie and Freddie are the primary causes of the crisis."





Sounds like you're working over a strawman to me. I think it's clear to any observer that this crisis was caused by a combination of (1) Congressional overseers who were on the take, from both GSE's and private business,en like Angelo, (2) he CEO's at F+F, who were bribing Congress and who were working hand in glove with those evil "loan originators", and (3) those evil "loan originators" as exemplified by Angelo Mozilo, who were bribing both the CEO's at F+F and also people on the Senate banking committee like Dodd.
10.21.2008 1:48pm
Duncan C. Coffee (mail):
"Anyone who believes that the main or central cause of this scandal is "affirmative action", "political correctness", or "diversity" is just applying a preexisting hatred of minorities to the current situation." - Dilan Esper

The rest of your post reads almost like it was written by an adult.

I'm sure you've read and come up with responses to Steve Sailer's collection of research on the matter, though your name is conspicuously absent from those who have replied to him.
10.21.2008 1:52pm
wyswyg:
No, I mentioned quite a few other blameworthy players: Credit agencies, the private entities who purchased MOST OF the mortgage securities, fraudulent borrowers, and you can add the Fed to that list as well.




Yeah, you're casting a wide net allright. Amazingly enough though, you somehow managed to miss such major players as the GSE's and the people in Congress who were working for the GSE's and the "loan originators". You also continue to pretend not to notice that the evil "private entities who purchased MOST OF the mortgage securities" were snugly in bed with both the GSE's and Congress.

Why is this so hard for you to understand? Or, more likely, to admit?



"You don't want to argue with what I've actually said"



Yes, I'm familiar with the classic evasion techniques of cornered lefties.
10.21.2008 1:55pm
Dilan Esper (mail) (www):
It was obvious to some of us DURING the bubble that Greenspan was making a huge error in treating inflation as purely a consumer price phenomenon, and ignoring the inflation in real estate as if asset price inflation beyond any historical precedent is not inflation.

I agree with this, Professor Bernstein. And that gets to my proviso in my comment, which is there may be good reason to take away from the Fed some or all of those aspects of banking regulation that don't have anything to do with monetary policy. With respect to those issues, not only did the Fed do a lousy job, but it seems to me that libertarians' objections about the Fed's setup and lack of accountability have much more force.
10.21.2008 2:37pm
Dilan Esper (mail) (www):
Oh please, Banks didn't suddenly wake up and realize they could get people to refinance and pay off the loans. That doesn't even make sense. People don't refinance to pay off the loans, the refinance to lower their interest rates or to take equity out gained by ponzi appreciation.

Actually, the way it worked was as follows:

1. Bank lent money to questionable credit risk with zero down payment, a teaser rate, and low monthly payments the first few years, and then a jump to an adjustable rate and higher payments.

2. Wait a few years and watch home values go up.

3. When it comes time for the rate and payments to go up, refinance the mortgage using the equity as a form of "down payment" and moving to a more affordable set of terms. Bank is now protected if homeowner defaults because value of home will make foreclosure sufficient.

So they essentially gambled on the market continuing to go up. Note that they would have done this with or without a CRA.
10.21.2008 2:40pm
Dilan Esper (mail) (www):
They (Austro-libertarians, that is) already have. A central bank with a fiat currency and interventionist policies tends to exacerbate and to some extent create boom-bust or, perhaps more accurately, bubble-bust cycles. (Since the inflation of fiat currencies tends to cause asset bubbles, malinvestment, etc.)

Actually, when you go off fiat currency and get rid of an independent central bank, you have deeper and longer recessions. You can see that by comparing the 19th and 20th Centuries in this country. I know that devotees of Austrian economists believe in their pretty little theory, but the fact is that countercyclical monetary policy is proven both in theory and practice to be the best way to smooth out the business cycle.

They actually were forced to make subprime loans though. That's what the CRA was. A system where they were rated on a point system by how many subprime loans they made and if they didn't make enough they were penalized by the government. I don't think this was the whole driver of the problem but you can't say it didn't exist when it clearly did.

We've had the CRA since 1977. Banks weren't making all these subprime loans until the late 1990's. Obviously the CRA had nothing to do with it-- and as I showed above, it is short-term rational for banks to make these loans even in an unregulated market as long as housing values are going up.

Well the solution is not to exacerbate the business cycle and turn it into a bubble-bust cycle in the first place.

And the way to do that is with fiat currency and a strong central bank engaging in countercyclical monetary policy. Otherwise, you get periodic significant panics.

And regarding the poor and middle class: There are few policies that screw over the poor and the middle class more than inflation does.

Moderate inflation doesn't screw the poor and middle class much at all, because their wages tend to go up over time to cover it.

Severe inflation would screw the poor and middle class, but we haven't had severe inflation in 30 years.

Inflation screws over seniors-- because they tend to be on fixed incomes-- and wealthy savers.

In any event, a moderate amount of inflation is a very good thing for monetary policy, because it provides room for the economy to expand and encourages people to circulate money rather than hoping it increases in value.
10.21.2008 2:47pm
wyswyg:
It would be a bad thing for people to hope that their money increases in value, because?

Moderate inflation doesn't screw the poor and middle class much at all, because their wages tend to go up over time to cover it.




No, that's not the case. Real median wages have been flat for decades now. Unless by cover it you mean, increases at about the same rate as inflation. In which case, why is inflation a good thing again?
10.21.2008 2:54pm
wyswyg:
"as I showed above, it is short-term rational for banks to make these loans even in an unregulated market as long as housing values are going up."




Housing values have been going up for a long time now. In the NYC metro area, for about twenty years. So according to you the banks should have been giving away no-money-down loans all this time.
10.21.2008 2:57pm
American Psikhushka (mail):
Dilan Esper-

So they essentially gambled on the market continuing to go up. Note that they would have done this with or without a CRA.

A huge part of the reason they felt more comfortable doing it was because of the extended asset bubble in real estate caused by the inflationary policies of a certain central bank. Not that it was excusable, it was horrible risk management. But this is a very good example of the malinvestment that Austro-libertarians attribute to inflationary policies. The overbuilding by the homebuilders is another example.

And although I may have overstated earlier, the CRA and the efforts supported by it did encourage this activity. Note that encouraging home ownership is fine, but encouraging loans that have a very high likelihood of defaulting does a disservice to both the lender and mortgage holder. Though it seems the originators and lenders that were able to sell these loans off did pretty well.
10.21.2008 3:05pm
Liberty Lover (mail) (www):
Hong Kong is even more of a libertarian success story. It rose from a baren rock to an economic success story in forty years. Milton Friedman pointed to it several times as an example of a nation whose government adopted a hands-off policy except for private property, contracts, and other essentials to make a market economy successful.
10.21.2008 3:40pm
Mahan Atma (mail):
This is cross-posted in the other thread, but it's worth posting twice.

This statistical analysis breaks out the subprime mortgage market and thoroughly demonstrates the much larger role played by by purely private entities as compared with Fannie/Freddie:

Primary Market -- Loan Originations

Fannie Mae and Freddie Mac do not originate mortgages. More than 80% of subprime loans still outstanding were originated in 2004 through 2007. The top ten subprime loan originators in 2006 were: HSBC Finance, New Century Financial, Countrywide Financial, Citimortgage, WMC Mortgage, Fremont Investment and Loan, Ameriquest, Option One, Wells Fargo Home Mortgage and First Franklin Financial. Seven of the ten (the nonbank lenders, who were not regulated by the Community Reinvestment Act) no longer exist, or were merged into banks. The lists for 2005 and 2004 were similar, but also included Washington Mutual. The top ten lenders accounted for about 60% of ALL subprime loans in 2006.

Secondary Market -- Wholesale Loan Buyers

In 2004, 2005 and 2006, securitized mortgages were 73%, 79% and 81% of all subprime mortgages. So for practical purposes the wholesale market was the securitization market. For the same three years, the total volume of subprime loans securitized was $521 billion, $797 billion and $814 billion respectively.

Almost none of those securities were issued by Fannie and Freddie. They were not in the business of purchasing and securitizing subprime mortgages, although they purchased some subprime mortgages to hold in portfolio, and issued about $6 billion in subprime securities in 2004 to 2006 (one-third of one percent of the market.) The top fifteen issuers of subprime mortgage-backed securities, accounting for about 75% of the market, in 2006 were: Countrywide, New Century, Option One, Fremont, Washington Mutual, First Franklin, Residential Funding (GMAC affiliate), Lehman Brothers, WMC, Ameriquest, Morgan Stanley, Bear Sterns, Wells Fargo Securities, Credit Suisse and Goldman Sachs.

Investors in Subprime Mortgage-Backed Securities

After the securities were issued, investors were needed to buy the securities, and thus to fund the mortgages. At this third stage, Fannie and Freddie did play a role, albeit a minor one. As of 12/31/07, Freddie held $234 billion and Fannie held $112 billion in subprime securities, out of a total market of $2,116 billion (i.e. $2.1 trillion). Most of these purchases took place in 2005 and 2006. A significant chunk to be sure (about 15%) but if you took out the GSE purchases, there would still have been a huge subprime market, and there is no way to know whether other buyers might have purchased those same securities if Fannie and Freddie had not (i.e. their presence was probably not vital to the growth of subprime lending and securitization.) Other purchasers of subprime securities included banks and thrifts, foreign investors including sovereign wealth funds, mutual funds, hedge funds, insurance companies, state and local governments, private pension funds, and wealthy institutions and individuals. It is also worth noting that Fannie and Freddie started buying subprime securities late in the game, years after the subprime mortgage market had been launched and its dangerous products deployed.

10.21.2008 3:51pm
Dilan Esper (mail) (www):
It would be a bad thing for people to hope that their money increases in value, because? Moderate inflation doesn't screw the poor and middle class much at all, because their wages tend to go up over time to cover it. No, that's not the case. Real median wages have been flat for decades now. Unless by cover it you mean, increases at about the same rate as inflation. In which case, why is inflation a good thing again?

1. If real wages are flat, that means they are covering the cost of inflation.

2. Moderate inflation greases the economy. If people think their money is going up in value, they are more likely to hold onto it rather than investing or consuming. Whereas if people know that their money will go down in value if they hold onto it, they are more likely to invest or spend it. So, in the longer term, you get much better economic growth if there is moderate inflation than if there is deflation.

Housing values have been going up for a long time now. In the NYC metro area, for about twenty years. So according to you the banks should have been giving away no-money-down loans all this time.

The longer the boom goes on, the more permanent it looks. That's why people were writing "Dow 36,000" in the 1990's-- because it had been so long since stocks had gone down that people started assuming there was some permanence to the situation.

Well, as the housing boom gets longer and longer, it looks better and better as a short term bet to do subprime teaser mortgages and then refinance them. Especially since there is a finite market of good credit risks and there was tremendous competition to make loans.

A huge part of the reason they felt more comfortable doing it was because of the extended asset bubble in real estate caused by the inflationary policies of a certain central bank. Not that it was excusable, it was horrible risk management. But this is a very good example of the malinvestment that Austro-libertarians attribute to inflationary policies.

Well, if we had those same loose money policies but had a regulated home market where it was illegal to make zero-down teaser mortgages and where proper documentation was required that could be examined by any rating agency, we also wouldn't have had this problem. Which kind of suggests that the regulatory issues were a bit more important than monetary policy (especially since loose money conferred other benefits on the economy, chiefly shortening the 2000-01 recession).

Hong Kong is even more of a libertarian success story. It rose from a baren rock to an economic success story in forty years. Milton Friedman pointed to it several times as an example of a nation whose government adopted a hands-off policy except for private property, contracts, and other essentials to make a market economy successful.

Note, however, that Hong Kong was a British territory (and is now a Chinese territory) which essentially gets a free ride on defense costs, is located in a strategically important part of the world, and has historically benefitted from its proximity to several important countries with import controls. That's a rather unique scenario.

Plus, Hong Kong's dollar has a fixed exchange rate to the US dollar, which means that basically Hong Kong's monetary policy is run by the Federal Reserve. It's not exactly following Austrian or Friedmanite monetary policy.
10.21.2008 3:55pm
American Psikhushka (mail):
Dilan Esper-

Actually, when you go off fiat currency and get rid of an independent central bank, you have deeper and longer recessions. You can see that by comparing the 19th and 20th Centuries in this country.

Deeper and longer than the Great Depression, which even some mainstream Keynesians and fellow travellers blame on the actions taken by the then fairly new Federal Reserve?

I know that devotees of Austrian economists believe in their pretty little theory, but the fact is that countercyclical monetary policy is proven both in theory and practice to be the best way to smooth out the business cycle.

Well, except when it makes depressions and recessions worse and/or longer, like many believe about the Great Depression, Japan's extended slump, etc. Or when this kind of inflationary interventionism leads to a hyperinflation and winds up trashing the whole currency and economy, as in Zimbabwe, Weimar Germany, etc.

We've had the CRA since 1977. Banks weren't making all these subprime loans until the late 1990's. Obviously the CRA had nothing to do with it-- and as I showed above, it is short-term rational for banks to make these loans even in an unregulated market as long as housing values are going up.

(By the way, your response just above was to a comment I didn't make. You mixed someone else's quote in with mine.)

Well as some of the quotes provided by wyswyg above showed, there was some social and political pressure to make these loans. I have a feeling that's the tip of the iceberg.

And when we're talking about 30-year (or at least 10-15 year) mortgages I don't know that we should be talking about something being "short term rational", except if your goal is to sell the loan off right away. (In which case your actions would probably be pretty shady, if not criminal, and whoever buys the paper would be pretty clueless.) That's horrible credit analysis and risk management.

And the way to do that is with fiat currency and a strong central bank engaging in countercyclical monetary policy. Otherwise, you get periodic significant panics.

Can you cite some examples please? Because the Great Depression and the various hyperinflations are often cited as some of the worst horrors caused by interventionist monetary policy and those seem much worse than the "panics" you mention.

Moderate inflation doesn't screw the poor and middle class much at all, because their wages tend to go up over time to cover it.

I know at least several people including, I believe, Hazlitt refuted this. If memory serves because the increase in wages lag the increases in prices too much. Unfortunately I don't have a cite at hand.

Severe inflation would screw the poor and middle class, but we haven't had severe inflation in 30 years.

A lot of writers disagree. Many say the inflation statistics stated by the government are routinely understated, often at half or less of the actual rate. I believe there's a lot on this at "shadowstats.com".

In any event, a moderate amount of inflation is a very good thing for monetary policy, because it provides room for the economy to expand and encourages people to circulate money rather than hoping it increases in value.

Seems like very minor and dubious benefits for the decline in buying power of currency. It amounts to a hidden tax that the vast majority of the population are unaware of much of the time. I don't think people would be so quiet about it if the government couldn't increase the money supply and had to actually increase the various tax rates to get this extra money for spending. With a fiat currency there is essentially no constraint on spending, a government can print or create the money any time it likes, directly confiscating it from the people.
10.21.2008 4:02pm
Dilan Esper (mail) (www):
Deeper and longer than the Great Depression, which even some mainstream Keynesians and fellow travellers blame on the actions taken by the then fairly new Federal Reserve?

Let's put it this way-- we had 3 or 4 Great Depressions with commodity-backed currency. And other countries had a bunch of them too.

The Federal Reserve system, fiat currency, and fractional reserve banking weren't created because people thought it would be a fun thing to try. They were created because other systems don't work.

Well, except when it makes depressions and recessions worse and/or longer, like many believe about the Great Depression, Japan's extended slump, etc. Or when this kind of inflationary interventionism leads to a hyperinflation and winds up trashing the whole currency and economy, as in Zimbabwe, Weimar Germany, etc.

The Federal Reserve wasn't in the main responsible for the Great Depression. You had poor banking and securities regulation, protectionism, and a partially commodities-backed currency that made it difficult to smooth out the business cycle.

Japan's extended slump was a liquidity trap. Nobody seriously believes, as far as I know, that it was caused by having a fiat currency / central bank system. Bear in mind that during the same period, dozens of other nation-states had central banks and fiat currency and outside of Asia they didn't experience what Japan did.

As for Zimbabwe and Weimar Germany, that's why you have to have an INDEPENDENT central bank like the Fed. There's no doubt that POLITICIANS may grossly inflate the currency. But independent central banks have a good record of resisting such pressure. The funny thing is a lot of the libertarian objections to the Federal Reserve would actually place monetary policy back in the hands of Congress, which increases rather than decreases the risk of hyperinflation.

And when we're talking about 30-year (or at least 10-15 year) mortgages I don't know that we should be talking about something being "short term rational", except if your goal is to sell the loan off right away. (In which case your actions would probably be pretty shady, if not criminal, and whoever buys the paper would be pretty clueless.) That's horrible credit analysis and risk management.

But that's what everyone was doing. And both parties are to blame here-- the Dems defended Fannie and Freddie, who securitized mortgages with their implicit federal guarantee, and the Repubs ensured credit default swaps wouldn't be regulated.

So it might not have been long-term rational, but it was short-term rational to loan the money and sell off the mortgage, with the buyer assuming that the mortgage would be refinanced after the home value increased.

I know at least several people including, I believe, Hazlitt refuted this. If memory serves because the increase in wages lag the increases in prices too much. Unfortunately I don't have a cite at hand.

Well, bear in mind that we have had moderate inflation for the last 28 years, and it while real wage growth has been anemic during some periods, there has never been a period where real wage growth trailed inflation. That's because the federal reserve was doing its job and controlling inflation. (Again, nobody argues that severe inflation wouldn't be a bad thing.)

A lot of writers disagree. Many say the inflation statistics stated by the government are routinely understated, often at half or less of the actual rate. I believe there's a lot on this at "shadowstats.com".

That's silly. If inflation were really shooting up, you'd see declines in the standard of living. We haven't seen that-- our worst periods have seen anemic growth in real wages, which isn't great, but isn't a disaster either.

Seems like very minor and dubious benefits for the decline in buying power of currency. It amounts to a hidden tax that the vast majority of the population are unaware of much of the time. I don't think people would be so quiet about it if the government couldn't increase the money supply and had to actually increase the various tax rates to get this extra money for spending. With a fiat currency there is essentially no constraint on spending, a government can print or create the money any time it likes, directly confiscating it from the people.

Look, if you think inflation is a form of "confiscation", then you simply have a principle you are attached to that is more important to you than whether the economy performs well.

Fiat currency is an illusion. That's the one thing libertarians are right about in this debate. Money isn't worth anything except what people will give you for it. And if everyone decides that the money is no longer worth anything, than the system breaks down.

The problem, though, is that if you decide to fix the value of money so that this can't happen, what you end up doing is creating a system where the money supply doesn't have the flexibility to countermand bad trends in consumer behavior. In other words, yeah, I guess when the Fed decides to inflate the money supply, there's an element of "confiscation" in that. But what the Fed is really doing is rewarding conduct that benefits the economy (i.e., putting one's money to work) and discouraging conduct that is harmful to the economy (hoarding one's cash). Inflation, in that way, is nothing more than a tax on hoarding, which is economically harmful activity.

Judged as such, it might be confiscation, but it is not WRONGFUL confiscation-- rather, it is just like any tax that seeks to discourage harmful activity. The Fed sets the tax rate and people respond to the incentives.

Again, if you just have a bug up your butt about the government making your hard-earned money worth less over time, you aren't going to like this. But the government is serving the common good by doing that. It's no different than any other tax. And any tax is justified if it effectively serves a particular compelling social policy. Given the importance of smoothing out the business cycle and ensuring that people don't hoard their money, this one does.
10.21.2008 4:39pm
David Warner:
Dilan,

"Not to say that too many subprime loans weren't given out, but there were plenty of market forces-- not just the CRA and the GSE's-- that led to this. (Essentially, it is short-term rational to give out teaser mortgages to people who ostensibly won't be able to pay them off during a housing boom, because you can always refinance the loans and pay the bank off.)"

Agreed. One of at least four key dynamics here. Might be useful to map them out and attempt to discern relative weights of importance.

"Anyone who believes that the main or central cause of this scandal is "affirmative action", "political correctness", or "diversity" is just applying a preexisting hatred of minorities to the current situation."

The above three phrases are not the same as criticisms of CRA or GSE's. On a libertarian blog, Occam's Razor suggests that it is the strong arm of the state embodied explicitly in the former and implicitly in the latter which is problematic, not the minority status of their putative beneficiaries.
10.21.2008 5:27pm
Dilan Esper (mail) (www):
David:

Note that I was quoting a commenter that used that language.

I agree it is possible to criticize the CRA without being racist or divisive about it. But when one wishes to do that, one wouldn't use the terms I quoted.
10.21.2008 6:40pm
MarkField (mail):
Cross-posting this discussion by economists to this thread as well.
10.21.2008 8:39pm
Brett:
And any tax is justified if it effectively serves a particular compelling social policy.


Comrade Lenin? Is that you?
10.21.2008 10:20pm
Brett:
[Without attempting to channel Sarcastro: "compelling social policy" is very nearly a contradiction in terms, and there is no tax yet invented that effectively serves anything except the ability of politicians to buy votes.]
10.21.2008 10:23pm
Dilan Esper (mail) (www):
Brett:

You must be trying to channel Sarcastro, because anyone who thinks that any sort of taxation to discourage harmful economic activity is the equivalent of Soviet Communism hasn't thought about these issues very hard.
10.21.2008 11:41pm
fishbane (mail):
But that's what everyone was doing. And both parties are to blame here-- the Dems defended Fannie and Freddie, who securitized mortgages with their implicit federal guarantee, and the Repubs ensured credit default swaps wouldn't be regulated.

Actually, to advance Fanny/Freddy interests. Whatever you think, it is a lot more bipartisan than this thread exposes. Not this thread exposes any interesting ways to fix things now.
10.22.2008 12:38am
David Warner:
MarkField,

From that same blog.

"A bit of intellectual honesty is required of free-market economists. Free markets work splendidly, in theory. But as no less a free marketer than the great Adam Smith himself observed in "The Theory of Moral Sentiments" ... free markets rely on specific social, moral and political institutions. These institutions must be exceedingly robust if the free market is to deliver on all of the splendid promises made for it."

She goes on to note some familiar political institutions.

I'll now proceed to dig an even deeper hole by claiming that Berlinski's list should include cultural and spiritual institutions as well. Obama and Palin each "get" this in their peculiar ways. Smith himself might disagree with them, though now he might not, given the more robust state of the spiritual institutions of his time, which may have led him to take them for granted, and the fact that effective spiritual institutions of this time have moved toward his (and Robert Wright's) theories of the importance of "sympathy" called by various names.
10.22.2008 2:03am
Brett:
You must be trying to channel Sarcastro, because anyone who thinks that any sort of taxation to discourage harmful economic activity is the equivalent of Soviet Communism hasn't thought about these issues very hard.


Let us take a moment to mourn the passing of another straw man. I never said that taxation to discourage harmful economic activity is the equivalent of Soviet Communism.

What I did say was that (a) the phrase "compelling social interest" is very nearly oxymoronic; and (b) there is no tax yet invented that effectively serves any purpose except vote-buying (the operative word there being "effectively").

And quite frankly, Dilan, if you think that the claim, "Any tax can be justified if it effectively serves a particular compelling social policy," doesn't smack of unreconstructed Marxism, then it's not me that hasn't thought about these issues very hard.
10.22.2008 4:28am
Dilan Esper (mail) (www):
I never said that taxation to discourage harmful economic activity is the equivalent of Soviet Communism.

You said "Comrade Lenin, is that you?" in response to a post arguing that taxation to incentivize economically beneficial conduct is justifiable. That's basically saying it's the equivalent of Soviet Communism.

And just so you know (because you repeat a milder version of the charge), Marx actually didn't have go into much detail about taxation policy in a liberal democracy. He was much more concerned about such things as putting the means of production under state control. Taxation of private sector activities is something capitalist economies, not Communist ones, tend to rely upon. Don't feel bad, though. You aren't the only one these days who is invoking Marxism without knowing what the heck Marx actually said.

What I did say was that (a) the phrase "compelling social interest" is very nearly oxymoronic; and (b) there is no tax yet invented that effectively serves any purpose except vote-buying (the operative word there being "effectively").

And this proves that I was right, you haven't thought these issues through. I can think of many tax policies that effectively serve the interests they are supposed to serve. The Earned Income Tax Credit, for example, does exactly what it is supposed to do. The Estate Tax is pretty effective at getting wealthy folks to give more money to charity. I am not much on the tax deductions for mortgage interest and employer-purchased health insurance, but both of them meet their goals just fine-- increasing home ownership and increasing the number of employers who provide health insurance, respectively.

Look, you can object to tax policy for this or that reason. But there's no doubt that people change their behavior because of the tax system. (Indeed, the funny thing is that the people who usually point this out are conservatives and libertarians.) And therefore, you want to tax inefficient and wasteful economic activity and incentivize better behavior. To the extent that a moderate, Fed-encouraged inflation rate creates a negative incentive to hoard currency, it's a perfectly justifiable tax.
10.22.2008 5:46am