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Does the Financial Crisis Discredit Libertarianism? Round II:

Arianna Huffington has a widely circulated op ed claiming that the current economic crisis discredits free markets. She provides very little in the way of evidence. There isn't much here that wasn't aired in Jacob Weisberg's similar piece back in October. So I refer interested readers to my rebuttal to Weisberg in this post. Huffington even imitates Weisberg's comparison between free market advocates and communists. This, I suppose, is the economic policy debate equivalent of comparing the Israelis to the Nazis and is about equally edifying.

Huffington also cites the recent New York Times article claiming that the crisis was caused in part by the Bush Administration's supposed commitment to free markets. I'm not going to analyze the article in detail here. However, I will note that it also emphasizes that the Bush administration engaged in considerable government intervention incentivizing financial institutions to issue mortgages to poorly qualified homebuyers as part of its policy of promoting homeownership. As the article puts it:

Mr. Bush had to, in his words, "use the mighty muscle of the federal government" to meet his goal. He proposed affordable housing tax incentives. He insisted that Fannie Mae and Freddie Mac meet ambitious new goals for low-income lending.

"Us[ing] the mighty muscle of the federal government" doesn't exactly sound like laissez-faire to me.

More generally, the notion that the Bush Administration had any serious commitment to free markets is laughable in light of the fact that it created the largest new government program in decades (the 2003 Medicare prescription drug bill), presided over the greatest expansion of government spending since the 1960s, and massively increased regulatory spending as well.

musefree (www):

More generally, the notion that the Bush Administration had any serious commitment to free markets is laughable in light of the fact that it created the largest new government program in decades (the 2003 Medicare prescription drug bill), presided over the greatest expansion of government spending since the 1960s, and massively increased regulatory spending as well.


That's what I find most dishonest about the Huffington-Weisberg crowd; their portrayal of Bush as a free market champion.

Here's my yesterday's post on the Huffington article.
12.23.2008 3:13pm
Leland (mail):
Oceania has always been at war with Eastasia.
12.23.2008 3:20pm
Dilan Esper (mail) (www):
There's several lines of thought here.

First, clearly, there were regulatory failures. The fact of the matter is that teaser mortgages were the result of the overriding of usury laws and preemption of state lender laws in favor of lax federal regulations that favored "the free market". And we don't have regulations of Credit Default Swaps and Hedge Funds because some powerful lobbies made "free market" arguments that libertarians accept. All these things contributed a lot more to the crisis than whether Fannie and Freddie guaranteed some loans they should have (remember, most of the bad mortgages were securitized by the private sector) or whether the government was overzealous in promoting minority homeownership.

Second, while Ilya is right about the governmental promotion of homeownership not being a libertarian idea, it is also not really one that libertarians spent a lot of effort trying to fight. Indeed, libertarians were promoting the "Ownership Society" along with conservatives, because libertarians tend to believe that property ownership has several beneficial effects on society. This doesn't mean that libertarians were necessarily supportive of efforts to lean on lenders, but it does mean that libertarians weren't exactly policing this issue (because it meant going after political allies as well as taking on an ideological contention about ownership that they had some sympathy with or mixed feelings towards).

Third, I think it's too broad to blame anything like this on libertarianism. Libertarians don't have a lot of political power; conservatives do and liberals did and will. But what Ilya seems to be really after is to counter any efforts to blame this crisis on laissez faire policies or free market policies. And that position seems untenable. Of course you can point to actions of the government that weren't good ideas which may have contributed to this. But the reality is that one of the problems with the free market is that if people can take their money out in the very short term, they don't have much of an incentive to price in longer term risk. And these mortgages lasted for 15 or 30 years. Thus, as long as someone else was going to be able to internalize the risk of a default, it made sense to make bad loans. This was true even without any pressure from the government or any "ownership society" programs.

The free market did this, because there are not any market mechanisms in the mortgage backed securities market to ensure the mitigation of long-term risk.
12.23.2008 3:24pm
Ilya Somin:
Second, while Ilya is right about the governmental promotion of homeownership not being a libertarian idea, it is also not really one that libertarians spent a lot of effort trying to fight. Indeed, libertarians were promoting the "Ownership Society" along with conservatives, because libertarians tend to believe that property ownership has several beneficial effects on society. This doesn't mean that libertarians were necessarily supportive of efforts to lean on lenders, but it does mean that libertarians weren't exactly policing this issue (because it meant going after political allies as well as taking on an ideological contention about ownership that they had some sympathy with or mixed feelings towards).

Libertarians and free market advocates did in fact warn about the risks of government backing for dubious mortgages and about the dangers of Fannie and Freddie several years before the crisis. I noted this in my Weisberg post linked in this one.
12.23.2008 3:30pm
Ilya Somin:
[T]he reality is that one of the problems with the free market is that if people can take their money out in the very short term, they don't have much of an incentive to price in longer term risk. And these mortgages lasted for 15 or 30 years. Thus, as long as someone else was going to be able to internalize the risk of a default, it made sense to make bad loans. This was true even without any pressure from the government or any "ownership society" programs.

In a free market, estimates of long term value are factored into short term prices. The reason why they weren't in this case is in large part because the government had implicitly backed Fannie and Freddie, and Fannie and Freddie in turn were willing to buy dubious mortgages issued by other lenders. Absent this, the incentive to make bad loans would have been far weaker.
12.23.2008 3:32pm
Mahan Atma (mail):
This has been documented multiple times in these comments threads: Fannie and Freddie were comparatively minor players in the mortgage crisis.

The large majority of the subprime mortgages bought on the secondary market were purchased by their purely-private competitors (e.g. Goldman Sachs, Bear, many others).

The numbers proving this are all out there, and I've linked to them several times before.
12.23.2008 3:35pm
einhverfr (mail) (www):
My own view is this:

I think the financial crisis discredits the idea that free markets operating alone and without regulation will solve these sorts of problems. I think that one idea of the link between free markets and government regulation is discredited.

However, there is another view to this and this is that the free market is a common good (or a good held in common) and maintained collectively by the federal government. This is the view I hold. Thus it is one of the government's jobs to ensure the survival and stability of the free market. In this view the bailout is something we can debate the wisdom or policy around, but is not something which is categorically bad any more than antitrust legislation (which protects the free market from being destroyed by the most powerful players) is.

I think that this crisis invites us to think about the connection between the free market, the government, and the consumer in a global economy. I think it discredits extreme libertarianism, but I don't think it discredits the idea that we need to be more libertarian in some areas (and maybe a little less in others).
12.23.2008 3:40pm
Mahan Atma (mail):
Fannie and Freddie by the numbers


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.

12.23.2008 3:41pm
einhverfr (mail) (www):
(I think that most political ideologies tend to be overwhelmingly flawed when they are taken in absolutist ways, however.)
12.23.2008 3:41pm
Mahan Atma (mail):
Another source:

In 2003, the two [Fannie and Freddie] bought $81 billion in subprime securities. In 2004, they 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.
12.23.2008 3:43pm
Curt Fischer:
I am confused why the discussion is centered on mortgages and consumer access to credit. It may be true that the failure of the residential real estate market precipitated the economic crisis, but it is also true that the residential real estate market was far from free. Government "regulation" (or "interference" if you prefer) in this market was indisputable.

If there are any areas where free markets have failed, and that government regulation may have made more sense, it is in the area of mortgage securities, credit default swaps, and other derivatives.

Letting undeserving consumers get loans for free or too cheap is not what led to a "crisis of confidence", a "liquidity trap", or to a recession as bad as we have now. It may have been a trigger, but the unregulated and unappreciated derivatives markets seem like a better place to focus.
12.23.2008 3:45pm
helloconrad:
With great respect to Professor Somin, I don't know how re-hashing conservative talking points on blaming the financial crisis on Freddie Mac and Fannie Mae gets to the core root of what's become a global economic crisis.

I think that most non-thinktank related economics agree that any numbers of bubble busts could have caused a U.S. financial crisis-housing notwithstanding.

While Paul Krugman points to the U.S. housing crisis as the onset of this nuclear mess we're in, Krugman also points to the collapse of the shadow banking system as the real culprit to this GLOBAL financial crisis. If the discussion is about defending the Free Markets(TM), then I suggest to you, Professor Somin, that you defend the idea of Free Markets at the "big picture" scale and start with defending/promoting the existing/more global financial non-regulation.

I don't think politically motivated chit chat (Ariana Huffington, really? You take what she says seriously?) should be any real barometer in judging which financial theory is more sound than not.
12.23.2008 4:00pm
Greg (www):
You can point to failures of overregulation and under regulation. Nothing in the government subsidies made the risk of default on individual loans any less. And nothing in the government subsidies made bundling high risk loans together make sense - especially when those bundles assumed default rates that were unrealistic. In his Portfolio article entitled The End, Michael Lewis discusses bond rating agencies whose models for home pricing wouldn't accept a negative number for home prices.

He called Standard &Poor's and asked what would happen to default rates if real estate prices fell. The man at S&P couldn't say; its model for home prices had no ability to accept a negative number. "They were just assuming home prices would keep going up," Eisman says.


That's not a failure caused by the backing of Fannie and Freddie, that's a fundamental, and misguided, belief that gravity doesn't exist! If S&P hadn't rated the securitized subprime mortgage bonds AAA, there would have been almost no market for the bonds and no incentive for more subprime loans.

And let's not even get into Credit Default Swaps which are entirely unregulated. That Bush promoted the Medicare drug benefit doesn't really impact whether or not his administration exercised the proper oversight over credit ratings agencies or whether they regulated credit default swaps.
12.23.2008 4:02pm
helloconrad:
economics economists
12.23.2008 4:03pm
cbyler (mail):
What exactly did the "undeserving consumers" get out of their "free" loans, anyway? A pile of liabilities and a large negative change in their net worth.

Taking out a loan is (generally) economically *bad* for the borrower - they always have to pay more than they get. The only exception is when they can use the loan to finance something so super-productive that it compensates for the loss of the loan itself and still results in a profit - a very unlikely scenario in reality, but one that lenders have huge incentives to promote. (Especially loan brokers that aren't exposed to the risk of default.)

IMO, most of the crisis is caused by good old-fashioned fraud and breach of fiduciary duty, with a large helping of corporate shell games. But nobody wants to talk about that because nobody knows where, or even if, it stops. Exposing the corruption in the system could do more to bring it down than the corruption itself is doing - or at least that's the fear, I think.


To return to the political issues - I think the confusion between laissez-faire (which Bush isn't) and crony capitalism (which he is) stems from the tendency of the market to try to corrupt government at the drop of a hat; if you try to keep government from meddling in business and end up without sufficient regulation to keep business from meddling in government, you get crony capitalism when you were aiming for laissez-faire.

In short, I think laissez-faire is a theoretical system that is never put into practice because it's, well, impractical. It tends to be subverted immediately, like communism; and like communism, its defenders keep falling back on the "but they're doing it wrong!" defense without realizing that it reveals a deeper flaw. Yes, Bush is doing free markets wrong, just like Stalin did communism wrong; but it's not an accident that systems with weak anti-corruption safeguards repeatedly suffer from rampant corruption.
12.23.2008 4:05pm
einhverfr (mail) (www):
Besides, the fact is that this crisis really hasn't destroyed consumer confidence in unregulation except that it has reminded us of the consequences of unregulated securities as we discovered in 1929.
12.23.2008 4:06pm
D Palmer (mail):
Ms. Huffington is a very entertaining speaker, but in this case she is so full of crap I'm surprised that she can see out her eye balls.

She is right that the housing crisis was precipitated and encouraged by reckless lending that resulted from Government pressure on lenders to make loans to "low income" buyers.

But that pressure came primarily from Congress and long pre-dated Bush's arrival in the White House.

Any effort to lay off the blame on Bush is revisionist history.
12.23.2008 4:11pm
LN (mail):

That's what I find most dishonest about the Huffington-Weisberg crowd; their portrayal of Bush as a free market champion.


Exactly! What I don't get is why the Huffington-Weisberg crowd complains about Bush, when they elected him in the first place.

I mean, who else would have voted for Bush in 2000 and 2004? Fiscal conservatives and free-market champions? Please. It was big-government liberals. Then they have the gall to blame Bush for being a disaster. They have no one to blame but themselves.

It's really so dishonest.
12.23.2008 4:12pm
Curt Fischer:

What exactly did the "undeserving consumers" get out of their "free" loans, anyway? A pile of liabilities and a large negative change in their net worth.


Well, some of them got to live in a fancy house way beyond their means for a bit, and then walk away (since they were "underwater" and mail the keys to the bank, all for the low low price of two years of low-interest mortgage payments and perhaps a lower credit rating. Doesn't sound like too horrible a deal to me.

Of course, some of the other consumers took out the loans in order to invest in real estate, not to live in it. They lost a little bit of money and also the credit rating, I suppose. It's hard to feel bad for them, though. They had the money to buy another house and wanted to make the investment risk.
12.23.2008 4:15pm
Bad (mail) (www):
There seems to be a lot of ducking and weaving on this issue.

Talking about the Bush team's creation of a huge government program simply isn't a reasonable or even a very effective distraction from the fact that they had a commitment to deregulation and lax enforcement and accounting (and many Wall Street Democrats were along for that ride) all based on the philosophy that these brilliant captains of industry knew best how to gauge risk and create sensible financial instruments.

The idea that the crisis all comes down to the government pushing loans to low income people is laughable Rush Limbaugh level nonsense. First of all, it wasn't even the government that was leading this market in the first place. As Mahan Atma notes, private banks were underbidding government instruments: as it always is, the government instruments were very late to the party, not being able to move anywhere near as quickly.

And the housing crisis just happens to be the prick that burst a much bigger bubble: that of utterly insane financial instruments like credit default swaps.

I'm a big fan of free markets. But I think you'd have to live under a rug to not realize that what we had here was largely a very tiny group of people making huge and rather nutty gambles with what has come to be the backbone of the entire economy. And there was very little transparency or serious attempt to enforce or regulate these things. Maybe that would have helped, maybe it wouldn't. But I think we're at the point where pointing at Medicare and complaining that the existence of government messes up the chance free markets had to make everything perfect just doesn't cut it anymore.

Personally, I think we're seeing huge failures of information. If the government wants to try having an effective role in dealing with this stuff in the future, I think it's there that we should look. There's just no way that scams on the level of Madoff should be able to survive so long, or that we can end up with assets that are so buried in subterfuge that no one really knows what they own.
12.23.2008 4:19pm
Don Miller (mail) (www):
I think it is ridiculous that as much as involved as our Government is in our economy that anyone could argue, with a straight face, that the current problems are a failure of the free-market system.

The Federal Government is a major player in the mortgage industry. You could legitimately argue Government Insured mortgages artificially kept the number of mortgages issued artificially high, but artificially reducing the risk of lenders. Lenders developed an attitude that if it all goes South, the Government will save us.

Government Bailouts of Companies that make risky decisions increases the likelyhood that the Companies will repeat the behavior again in the future because the negative consequences of business failure are removed.
12.23.2008 4:21pm
Leland (mail):
The free market did this, because there are not any market mechanisms in the mortgage backed securities market to ensure the mitigation of long-term risk.

In a free market, you don't need a GSE FNMA. The reason for the FNMA is to mitigate risk via an insurance, whose premiums are paid by the taxpayer and not the person making the risk. If the risk and insurance was paid by the lender, then the risk would be properly weighed.

When the insurers could no longer afford the burden they took on, the credit market froze. This could happen in a free market, but if it did, then the bad assets would sour and the companies with them would fail. If Bush was a proponent of free markets, he would never had signed a bailout bill, or asked for one.

D Palmer said it more directly than my odd comment, but to suggest free markets caused this, and that Bush was a free marketeer is to revise history. The fact that the revision is being made to support a socialist/communist approach to markets make my first comment rather apt.
12.23.2008 4:22pm
Andy Freeman (mail):
> remember, most of the bad mortgages were securitized by the private sector

Under what president did said "securitization" become legal?

As to how many sub-prime mortgages Fannie and Freddie bought, they effectively provided the standard and a default market, serving much the same purpose as T-bills serve to the commercial credit market today.
12.23.2008 4:26pm
LN (mail):
Do you guys think the Soviet Union was really Communist? You think it was pure?

Of course not. Real Communism has never been tried, only failed.
12.23.2008 4:29pm
Randy R. (mail):
LN> ::I mean, who else would have voted for Bush in 2000 and 2004? Fiscal conservatives and free-market champions? Please. It was big-government liberals.

You mean conservatives voted for Kerry and Gore? That's ridiculous. In both elections, almost the entire religious right wingers voted for Bush, and most everyone who considered himself a conservative and./or Republican.

Big gov't liberals did not vote for Bush. But if you have any evidence other hand pure speculation, let's have at it.
12.23.2008 4:33pm
Dilan Esper (mail) (www):
In a free market, estimates of long term value are factored into short term prices.

That's an assumption, not something that's always true. In a speculative market, there is actually often the belief that the next guy is going to be the sucker. Further, ratings agencies (again, not a governmental institution) attached overly pollyannish ratings to these securities, and the mere act of securitization itself diffuses risk. Thus, you had sellers who knew that they were selling poison and buyers who didn't know that they were buying it (or didn't care, because they were going to sell it to someone else).

I sometimes think that Ilya never got past Econ 101 and the supply and demand curves. The economic effects of imperfect information are complicated (they are quite above my layman's understanding of economics), but certainly no honest and knowledgeable economist would simply assume that estimates of long-term value get factored into short-term prices.
12.23.2008 4:33pm
LN (mail):

But if you have any evidence other hand pure speculation, let's have at it.


Does sarcasm count?
12.23.2008 4:43pm
JosephSlater (mail):
You know, as soon as I read Ilya's post, I thought of comparing it to the "but REAL communism has never been tried!" folks. Then two people beat me to it.
12.23.2008 4:47pm
cgb:

But I think you'd have to live under a rug to not realize that what we had here was largely a very tiny group of people making huge and rather nutty gambles with what has come to be the backbone of the entire economy.


This crisis was not precipitated by a "very tiny group of people," it was precipitated by a very large group of people making nutty decisions with credit -- which came to be the backbone of the entire economy.

And I'm not referring to the credit necessary to start and to run a small business during. I'm referring to consistent over-consumption credit.

We (collectively speaking) took out the loans. We bought the cars. We bought the plasma TVs. And by doing so, we "created" jobs that really shouldn't have existed (and now have to go away), and discouraged investment into jobs that should have existed. Until we man up and realize that the credit consumption economic fantasyland is never coming back, we'll never move past this to a true solution. Blame regulation or deregulation all you want, but people still decide how to spend money in this country, and they spent it into the ground.
12.23.2008 4:48pm
Mahan Atma (mail):
"As to how many sub-prime mortgages Fannie and Freddie bought, they effectively provided the standard and a default market, serving much the same purpose as T-bills serve to the commercial credit market today."


Can you spell this out -- how did this "standard" work, exactly?

Look through the list of purely-private players in my post above. These companies were making buckets of money at the time. Exactly how did Fannie/Freddie help them make so much money, when they were competitors?

Are you saying the purely private companies couldn't have done this if there hadn't been Fannie/Freddie? If so, why not?

Seems to me that if there had been no Fannie/Freddie, the purely private companies would have done the same thing, only they would have had 100% of the market instead of 60-70%.
12.23.2008 4:56pm
AnonLawStudent:
The answer is likely a combination of two ideas

[I]t is ridiculous that as much as involved as our Government is in our economy that anyone could argue, with a straight face, that the current problems are a failure of the free-market system.

[Advocates of increased regulation] never got past Econ 101 and the supply and demand curves. The economic effects of imperfect information are complicated . . . .

The economy is an insanely complex system with random, non-linear, and unknown variables. Unfortunately, too many people (particularly in Congress) think that such a system can be forced to behave in a certain way; regulations-piled-on-regulations often result in unanticipated outcomes. Did Fannie/Freddie, the CRA, non-recourse mortgages, tax incentives, complex capital standards (e.g. Basel), and a lack of transparency contribute to the present situation? Of course - they all did. The real libertarian critique is that government should focus on its principal/legitimate role in the economy - ensuring transparency in the market - and quit trying to enforce particular substantive outcomes via regulation.
12.23.2008 4:57pm
AnonLawStudent:

Can you spell this out -- how did this "standard" work, exactly?

Take a look at the spread between conforming and non-conforming loans, then try to argue that Fannie and Freddie didn't set a market standards.
12.23.2008 5:02pm
Mahan Atma (mail):
Doesn't "regulation" include the enforcement of laws against fraud?

When a mortgage broker encourages a borrower to take a "liar's loan" by falsely stating their income, are not both parties committing fraud?

When a rating agency assigns a AAA rating to a security it knows is far too risky to deserve such a rating, isn't this also fraud?

These were both huge factors in the mortgage crisis, and both were due in large part to "deregulation" in form of a lack of enforcement of existing laws.

Furthermore, the Bush administration deliberately put in charge people with no appetite for the enforcement of existing regulations (see Cox at SEC).

This was the real failure of deregulation.
12.23.2008 5:06pm
A. Zarkov (mail):
"Of course, some of the other consumers took out the loans in order to invest in real estate, not to live in it. They lost a little bit of money and also the credit rating, I suppose. It's hard to feel bad for them, though. They had the money to buy another house and wanted to make the investment risk."

The mortgage is non-recourse only for the primary residence and only for purchase money. If someone owns a bunch of houses that are all underwater and walks away from them, the lender can sue him for the difference.
12.23.2008 5:08pm
Mahan Atma (mail):
"Take a look at the spread between conforming and non-conforming loans, then try to argue that Fannie and Freddie didn't set a market standards."


But so what -- how did this cause the crisis that emerged?

I ask again: The purely-private firms were making money hand-over-fist. If Fannie/Freddie had been shut down in 2003, what would have prevented the purely-private firms from taking over 100% of the market, instead of 60-70% of it?
12.23.2008 5:13pm
anomdebus (mail):
Thought experiment (not directed at anyone in particular):

The government tells a market to do something, it complies in a way that causes problems later. Who is at fault? (assuming the market would not otherwise have done that something, why would the government have to tell them in the first place if they would have done it anyway?)



Note: I am not attempting to say this is the sole reason, I just think it is somethink like a rorschach test
12.23.2008 5:44pm
LN (mail):
Another thought experiment: two years ago, if someone had said that the federal government was largely responsible for Dow Kim's $35,000,000 bonus, how would the commenters here have replied? What if someone had wondered if Merrill Lynch was being shortsighted and pursuing illusory short-term profits?

Would anyone have said, "Well, what do you expect, the economy is being run by the government, of course Merill Lynch is being short-sighted, Barney Frank is creating the opportunities for Dow Kim to make himself a lot of money."
12.23.2008 5:59pm
einhverfr (mail) (www):
Joseph Slater:

You know, as soon as I read Ilya's post, I thought of comparing it to the "but REAL communism has never been tried!" folks. Then two people beat me to it.


I dunno. Over the last thousand years, Iceland has seemed to go from entirely Libertarian to pretty darned near the "REAL Communism" that such people talk about.....
12.23.2008 6:08pm
musefree (www):
I think this point has been made before but it is worth repeating. The libertarian position is not that the free market necessarily leads to the most efficient theoretical outcome in all circumstances. Rather, (most) libertarians make the more modest claim that government regulation usually leads to even worse outcomes. It is not enough to say that the free market failed, it is also necessary to contemplate whether the regulation proposed will make things worse, not just in the particular economic parameter but also in its overall effect.

Also, libertarians do not necessarily oppose (all) regulation. For instance I support light-touch regulation that preserves choice but only mandates clear information disclosure, so that both parties entering a contract know exactly what they are getting into.

The reason articles like Weisberg's or Huffington's are terrible is because they are: completely irrational in their failure to realize that every problem is one of alternatives, utterly dishonest in their false understanding and portrayal of libertarians (I mean, they think of Bush as a laissez-faire absolutist), intellectually dishonest in their refusal to even attempt real analysis.
12.23.2008 6:09pm
MQuinn:
Professor Somin said:

Huffington also cites the recent New York Times article claiming that the crisis was caused in part by the Bush Administration's supposed commitment to free markets. I'm not going to analyze the article in detail here. However, I will note that it also emphasizes that the Bush administration engaged in considerable government intervention incentivizing financial institutions to issue mortgages to poorly qualified homebuyers as part of its policy of promoting homeownership.

The NYT article's argument is structured to avoid the above-quoted argument. The article argued that Bush's failure to regulate those lending to citizens under the home ownership policy caused the financial meltdown. In other words, the article suggests that, had proper regulations been in place, the financial meltdown would not have occurred, even had the home ownership policy been in place, thus avoiding Professor Somin's argument.

More generally, the notion that the Bush Administration had any serious commitment to free markets is laughable in light of the fact that it created the largest new government program in decades (the 2003 Medicare prescription drug bill), presided over the greatest expansion of government spending since the 1960s, and massively increased regulatory spending as well.

Again, I think that this misses the mark, at least with respect to the NYT article. The issue is not the size of government programs or the amount of government spending. Instead, the issue is the lack of government regulation, which seems to me to be an entirely different animal than, say, the prescription drug bill. (of course, the point that regulatory spending increased under Bush is relevant)
12.23.2008 6:14pm
Andy Freeman (mail):
> Can you spell this out — how did this "standard" work, exactly?

Fannie and Freddie told the market "we'll buy everything that meets {standards} at {price}". So, if Citicorp (for example) bought one of those things for a bit more than {price}, it knew that its risks were limited because if all else failed, it could always re-sell said thing to Fannie and Freddie for {price}.

This lets Citcorp get whatever profit it expects to make on the whole deal while effectively only risking the difference between the price it pays and the price that Fannie and Freddie would pay.

It's like insurance, except that no one paid premiums.

Ordinary securities and bonds don't work that way. If there's insurance, one of the parties pays and there's always the chance that the insurer will fail. If there's not insurance, the owner's complete investment is at risk.

And then there's the tax and regulatory preference given to banks that held fannie and freddie stock and debt. When those plunged in value, a lot of institutions became technically insolvent.

What "free market" principle says that a certain company's stock should be counted differently?
12.23.2008 9:03pm
LN (mail):
Right; all the banks knew that they weren't really taking on any risk, because the government would step in and save them.

That's why all the banks have been completely fine throughout the financial crisis: the government stepped in and saved them. Shares of Goldman, Lehman, AIG, none of them have gone down in value, because the government bailed them out. The market correctly perceived that there was no downside.
12.23.2008 11:26pm
Mahan Atma (mail):
"So, if Citicorp (for example) bought one of those things for a bit more than {price}, it knew that its risks were limited because if all else failed, it could always re-sell said thing to Fannie and Freddie for {price}."


So please explain how Citicorp and the other institutions managed to lose so much money in the long run.
12.24.2008 12:07am
Ricardo (mail):
Fannie and Freddie told the market "we'll buy everything that meets {standards} at {price}". So, if Citicorp (for example) bought one of those things for a bit more than {price}, it knew that its risks were limited because if all else failed, it could always re-sell said thing to Fannie and Freddie for {price}.

You are claiming that Fannie Mae and Freddie Mac explicitly set a floor on the price of subprime mortgage-backed securities, that this floor was widely known among investment banks and that it regularly intervened in the market to maintain this floor price. Moreover, given that the market for mortgage-backed securities has collapsed, there must have been some point in time you can point to when Fannie and Freddie withdrew their guarantee leaving investment banks holding the bag. And this date must be before the failure of Bear Stearns and its hedge fund operations -- which was in turn months before the time when Fannie and Freddie were on the brink of insolvency.

Note that anything less than an explicit guarantee leaves much of the responsibility of leveraged bets on mortgage-backed securities with investment banks. Investment banks stab each other in the back all the time on trades -- that's what traders get paid to do. Why should be apply different standards when the counterparty is a quasi-government agency?
12.24.2008 5:09am
David M. Nieporent (www):
The mortgage is non-recourse only for the primary residence and only for purchase money. If someone owns a bunch of houses that are all underwater and walks away from them, the lender can sue him for the difference.
Most mortgages are non-recourse de facto, if not de jure; yes, the lender can sue him for the difference, but if it can't collect, what good does that right do for it?

(Now, ordinarily one who has bought numerous investment properties might be thought to have assets against which one can levy -- but in this context, that's not a reliable assumption anymore.)
12.24.2008 11:00am
AnonLawStudent:

Most mortgages are non-recourse de facto, if not de jure; yes, the lender can sue him for the difference, but if it can't collect, what good does that right do for it?

David, I think it is a matter of deterrence. In a non-recourse state, mortgagors have little incentive to continue payments on a mortgage secured by underwater property; indeed, the only economic incentive is the effect on credit rating. In contrast, the possibility of an adverse judgment adds a significant incentive to avoid jingle-mail.
12.24.2008 11:42am
Andy Freeman (mail):
> Why should be apply different standards when the counterparty is a quasi-government agency?

Everyone thought thought that Fannie and Freddie had "full faith and credit", just like T-bills. No one ever thought that Bear Sterns or Citicorp did. (Although, it turns out that some financial institutions did have that backing, no one knew which ones in advance.)

Yes, it turns out that the fannie and freddie weren't as reliable as T-bills (or maybe the US govt will some day refuse to pay back t-bills), but that's hindsight.
12.24.2008 12:01pm
LN (mail):

Everyone thought thought that Fannie and Freddie had "full faith and credit", just like T-bills. No one ever thought that Bear Sterns or Citicorp did. (Although, it turns out that some financial institutions did have that backing, no one knew which ones in advance.)

Yes, it turns out that the fannie and freddie weren't as reliable as T-bills (or maybe the US govt will some day refuse to pay back t-bills), but that's hindsight.



So private market actors made a miscalculation, but it's the government's fault because their miscalculation was about the government? Makes sense to me! (Note that this isn't a matter of the government changing a law or regulation, thereby disrupting plans for the future.)
12.24.2008 12:20pm
Andy Freeman (mail):
> So private market actors made a miscalculation, but it's the government's fault because their miscalculation was about the government?

The question was why the private market actors treated things that Fannie and Freddie approved differently than they treated things approved by, say, Citicorp.

Until earlier this year, folks treated Fannie and Freddie as if they had full faith and credit because the relevant pols said that it did. The more honest added "it's not statutory, but don't worry about that - we'll back it up."

The realization that Fannie and Freddie weren't as "sound as a dollar" came over time, but that was fairly recent.
12.24.2008 5:35pm
LN (mail):
I don't understand. Have Freddie and Fannie defaulted yet? But huge chunks of the banking industry have been wiped out.

For example, how do you explain AIG's failure in this story?
12.24.2008 10:06pm
Careless:
"I don't understand. Have Freddie and Fannie defaulted yet? But huge chunks of the banking industry have been wiped out.

For example, how do you explain AIG's failure in this story?"

Where were you in September? No, they didn't default because the government promised them hundreds of billions of dollars. AIG was not a government sponsored entity and apparently didn't buy enough congressmen, so it died.
12.25.2008 12:11am
LN (mail):
Geez. Can someone make this story coherent?

1. The government created the crisis by guaranteeing Freddie and Fannie. This distorted incentives for market actors.
2. Freddie and Fannie didn't default. In other words, people who thought the government would bail out Fannie and Freddie were right.
3. Bye bye investment banking, bye bye AIG, hello global financial meltdown.

This just looks like a really pathetic attempt to blame massive miscalculations made by non-government actors on the government. What am I missing?
12.25.2008 1:02am
Smokey Behr (mail):
I don't know why nobody has mentioned the lawsuits filed against the banks and other lenders by ACORN and other "community organizers" to force the lenders into lending to people that obviously can't afford the loans.

Another thing is the large number of "NINJA" loans. "No Income, No Job or Assets" would get you laughed out of a bank faster than a clown on crank. It's like the old In Living Color "Homeboy Shopping Network" sketches... "No job, no problem; no credit, no problem; no money, PROBLEM."
12.26.2008 5:10pm
Andy Freeman (mail):
> 1. The government created the crisis by guaranteeing Freddie and Fannie. This distorted incentives for market actors.
> 2. Freddie and Fannie didn't default. In other words, people who thought the government would bail out Fannie and Freddie were right.
> 3. Bye bye investment banking, bye bye AIG, hello global financial meltdown.

> This just looks like a really pathetic attempt to blame massive miscalculations made by non-government actors on the government

Not so fast. The claim that this was all non-govt actors rested on an assumption that Fannie and Freddie were ordinary and didn't distort the economy. They argued that Fannie and Freddie were irrelevant because they didn't have 100% of the market.

However, Fannie and Freddie did distort the market by providing a "risk-free" floor that turned out to not be. (The bailout didn't keep fannie and freddie buying.)
12.27.2008 2:54pm

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