I first and foremost blame the sub prime borrowers because, as I've said before, none of us would be in this mess if they did what they said and paid back what they owed. Thusly I assign a 23% blame on them.
However, it's not like financial dead beats could have done this on their own. They needed help. Specifically, they needed some moron to loan them the money and here I blame mortgage brokers and lenders. In the past these people would have normally weeded out the sub prime dead beats from borrowing money in the first place and summarily denied them the loans. However, driven by commission and short term profits, these idiots lent money out they knew they would never get back. Thusly, I assign a 17% blame to them.
Now, unbeknownst to most people, and arguably the main point of my book (which you should buy), is that the media and society only focus on one side of the housing crash problem; demand. All we ever look at is how demand was artificially inflated by shoddy, if not, absent lending controls, a flood of sub prime dead beats entering the market and easy credit. Nobody looks at the other side of the equation and that is supply. Here the exact same story was repeating itself.
For it wasn't just sub prime dead beats that wanted to own houses, but scumbag, moronic real estate developers who wanted to build more and more housing and sell it at inflated prices. These people are just as much to blame, for as much as the sub prime dead beats artificially inflated demand, these crooks skyrocketed supply. And so much did they boost the supply of housing, they flooded the market with it, which drove prices down and made it impossible to sell your house for anywhere near what you paid for it. I blame them precisely as much as I do their demand-side counterparts - 23%.
Again, these real estate developers could not have done this without help, and here is where the fourth culprit lie - banks and bankers. Banks, blinded by what they deemed to be perpetual commission for continually approving $35 million suburbanite real estate development deals, would pay no heed to the burgeoning level of supply they were dumping on the market. And since they didn't care about how much supply was hitting the market, they also didn't care if it would bankrupt them, necessitating a taxpayer financed bail out. They put their commission ahead of not only the long term longevity of the bank, but from lessons learned from the S&L bail out, they knew the taxpayer would be stuck with the bill. They are equally to blame for the mortgage banking scum that lent so frivolously to the sub prime deadbeats - 17%.
The two sides of the economic equation, supply and demand are accounted for, but it behooves the question "what were people thinking?"
Well most "people" were neo-Americans, accustomed to not having to work or pay for anything. It was their entitlement mentality that they were entitled to a house, entitled to a flat panel TV, entitled to a convertible and entitled to a life. Additionally, most neo-Americans put themselves first above and beyond all others, so even if Banker Bob knew lending money to Developer Dave would result in a $10 million loss for the bank, what did he care? He was going to get a cool $100,000 commission off that deal. Besides which, he had no loyalty to the bank, he was already looking for another job. It was this childish, me-first-at-all-costs-including-tanking-the-US-economy mentality that created the environment by which the housing bubble and subsequent crash could fester. Ergo, it is the spoiled brat, entitlement, American psychology that is to blame, earning 13% of its share.
The two remaining culprits were simply responding to what Americans and society wanted. Investments banks, though not the originators of the loans, accelerated the bubble by allowing the originators to sell the toxic loans they did make. This disassociated the originator holding onto the risk of the loan and gave them great incentive to go for volume and approve everything under the sun. Again, adhering to the "me-first" mentality, investment banks passed on crappy loans to unsuspecting investors, of course, not without first, getting their cut in commission - 4%
And finally, how can a good ole fashioned bubble form without the implicit consent of the good ole government. Again, prompted by the desires of neo-Americans to have everything for free, and always eager to use taxpayer money to buy votes at the expense of society, democrats (primarily) through the years instituted policies such as the CRA that somewhat sternly suggested banks lend to losers and scumbags. Fannie Mae and Freddie Mac were the government intermediaries that made this possible as they financed/guaranteed the mortgages made to the most rotten, degenerate scumbag borrowers. And if you weren't for giving away free houses to the poor, you were a racist, nazi, sexist fascist. Of course, the "government" is really just an illusion, as last I checked this was a democracy and it is the people who govern, thereby making the government just a condoner of the things going on and earning it a 3% share of the blame.
I think the Entitlement Mentality deserves more then 13% of that chart. Without that, the bankers, developers, etc... would not have been so inclined to make a buck regardless of the long term effect.
ReplyDeleteAside from that, real good chart.
Oh thanks that breaks it down rather nicely.
ReplyDeleteOf course, one thing to remember in the longterm is that it's not the pieces of the pie that matters but the overall size.
You forgot the source of the fuel for the fire. This source deserves a large share of the blame too. The Federal Reserve created the artificially low interest rates, thus creating massive amounts of money out of thin air that allowed this housing bubble to happen. If the cost of borrowing money was at a true and higher free-market value, many bankers would have been more cautious. I'd give the Fed an equivalent share to the sub-rime borrowers.
ReplyDelete"Of course, the "government" is really just an illusion, as last I checked this was a democracy and it is the people who govern, thereby making the government just a condoner of the things going on and earning it a 3% share of the blame."
ReplyDeleteThose bastards spend a full third of US GDP and have the power to regulate nearly every aspect of the economy if they so choose, and somehow they're just an illusion? The Fed doesn't even make the chart? What the hell, Captain?
I'd like to offer my counterpoint, which I call "Blame the government and the Fed for everything". Without their bad policies, this never would have happened, regardless of the stupidity, irresponsibility, and entitlement psychology of any of those other groups. The specific programs I'm talking about are the FDIC, the fiat currency system of central banking, and fractional reserve banking. To start with, the Fed's easy money policy and the government removing capital gains taxes on housing (without removing them on other types of capital in 1997) got the housing bubble started. All this stuff afterwards is what enabled it to keep going.
The US government and the Fed are both more resonsible for the mess because they are the enabling force behind the rest of the stupidity. The Fed's expansionist monetary policies combined with the fractional reserve system based on fiat currency allows banks a truly ridiculous amount of liquidity without having to offer high interest rates to attract deposits. They can loan out far more money than anyone ever puts into them and they don't have to worry about over-leveraging themselves because the government has taken steps to prevent the type of competitor-engineered bank runs that kept 18th century Scottish banks from overleveraging themselves. (Scotland is a great example because their banking industry was about as freewheeling and cut-throat as a financial sector can get and makes for a wonderful contrast to the regulated, protected sissy-party of entitled old money bastard bankers that we have today)
As a result banks can loan out nearly limitless amounts of money. If banks had to attract loanable funds by offering a higher interest rate on deposits, you can bet they wouldn't have been throwing money around like they were. That means the sub prime borrowers, real estate developers with bad business plans, and spoiled brats who want to live beyond their means would have to walk away empty handed. Their stupidity was able to coalesce into a catastrophe because easy fiat money made it possible. Not only that, but the spoiled, entitled attitude of many people is in part a product of the fractional reserve system. Banks offer next to nothing in interest on deposits because the fractional reserve system makes their liquidity easy to come by, which discourages savings and thrift. Easy credit (also a product of banks' easy liquidity) encourages spending beyond one's means. It's not the only cause for this stupid behavior, but it's a push at making it worse.
Any discussion of the housing bubble and crash would be incomplete without mentioning investment banks and collateralized debt obligations. Mortgage backed securities are a subset of these relatively new financial instruments. Since banks only have to keep a small fraction of their obligations on hand, selling those obligations to a third party for their full value gives them a huge increase in liquidity. Investment banks were stupid to buy this sub-prime backed garbage, which makes them one of the few parties that screwed up entirely under their own power, instead of being helped into stupidity by the Fed or the government. That said, without the Fed and the US government screwing up those bad loans wouldn't have been made in the first place, so while they are in part responsible they also would be in much better shape if not for the rest of the retard-rodeo set up by the people running things at the government and the Fed.
So, what could we do to avoid this sort of thing in the future? Abolish the Fed and switch back to commodity backed currency to get a stable money supply. That will prevent bubbles of all sorts without anyone even having to see them coming. Also, do away with the FDIC and anti-competitive regulations so that banks can kill each other at the first sign of weakness. An occasional bank failure who is then absorbed by their surviving competitors is preferable to masses of banks failing at once like we have now. Our current system is based on fiat and good faith, both of which are as ephemeral as the promises of the government. Good faith makes bad currency.
I suppose if you were a judge, assigning liability in a case of comparative negligence, your pie chart would be an acceptable apportionment.
ReplyDeleteI prefer to think of blame, though, as existing in limitless supply. To use an extreme example, if someone were mugged while flaunting cash in a bad neighborhood, I can blame the victim for stupid behavior without removing one iota of guilt from the criminal.
Then there is the doctrine of 'root cause', something of which I am normally highly suspect because it usually involves blaming others for your own criminal behavior. But in this case, I squarely assign the root cause to government. The various parties always had an incentive to be greedy. But when government lowered their expectations of lending practices, allowed risky products, encouraged people to buy, facilitated securitization, gave tax incentives, lowered interest rates, and pushed GSEs into flooding the market with liquidity, that's when and why this all began. Government intervention, not the free market, was the failure - all in the name of affordable housing.
I place no blame on the Federal Reserve.
ReplyDeleteI think Congress has not been assessed enough blame - and I don't buy into government getting only 3% because we voted them in and thus it's really our fault. I think Ryan is right on.
ReplyDeleteThe question I have is why we even had a Fannie Mae and Freddie Mac - why the Congress create two government corporations to duplicate hte private sector?
"I place no blame on the Federal Reserve."
ReplyDeleteReally, none at all? Do you believe that it's possible for the Fed to screw up? If so, what kind of epic catastrophe would it take if this isn't big enough?
Markets clear. Banks loan out the money they have access to. This is one of those eternal principles like fish swimming, politicians lying and bears shitting in the woods.
The Fed has taken it upon itself to control the money supply and interest rates, so when they screw up and money starts flying around like confetti at a parade while interest rates have sunk below the rate of inflation meaning that they're paying banks to take money, it's their fault.
Lending standards will shift based on how much money banks have at their disposal in order for banks to avoid sitting on money they could be collecting some interest on. If banks didn't have a ridiculous amount of liquidity at their disposal their standards would be different. The Fed has created an environment of easy money, which leads to lax lending standards, which leads to idiots getting loans they shouldn't be getting, which fuels asset bubbles and sets up a credit crash.
The Federal Reserve is also a bank regulator.
ReplyDeleteYou may not blame them for instituting necessary monetary policy in the early 2000's, but don't you blame them for failing in their examination duties just like the other regulators?
In one sense you place too much blame on bankers, borrowers and developpers. They were responding to supply and demand - and I don't believe they became scummier in the last 10 years - what happened is they didn't have to hold their investments, thus they didn't have to care what kind of loans to put out. If Freddie and Fannie will buy my flaming bags of poo, I'm going to keep on pooing for profit.
ReplyDeleteSo I put the blame on the CRA crap - which is just another way of saying I blame Americans who elected these do-gooders. So all in all - my pie chart looks like this - The American People 100%.
An interesting economic question for an economist with time on his hands is to analyze the effect of restrictive development policies on the bubble. Here in California it is difficult and expensive to get a development approved. My guess is that the prices have to rise by a good amount before a developer submits a proposal. However, this price rise has attracted developers to other cities in the market as well, creating a rush of supply which is difficult to pair with demand over the long term. Now if it were easy to put up a development, supply would quickly match demand and prices would not be as volatile. That's my hypothesis anyway.
ReplyDeleteJaimeroberto:
ReplyDeleteExplain to me why you think it is hard to get a development approved in California. I really don't know the process.
It didn't seem so hard to get approval in the Central Valley and the East Bay. Are permits locally controlled or are there state restrictions?
Given that California derives a significant amount of revenue from property taxes, I don't believe they would stand in the way of development.
Housing starts and permits were at record highs in 2005.
It would seem prudent to have some sort of coordination mechanism for developers to prevent overbuilding, similar to cap-and-trade for emissions.
What you say is certainly true for the capacity constrained urban areas like San Francisco. The city rigidly controls permits. I don't think Antioch, Modesto, or Fresno did.
I've never quite understood this opposition to the Federal Reserve. Some of the anti-feds want to raise the reserve ratio to 100% for no apparent reason.
ReplyDelete"I've never quite understood this opposition to the Federal Reserve."
ReplyDeleteThey suck at their job. Interest rates should be a function of the supply and demand for loanable funds, not some shot in the dark by central planners. When central planners guess too high they stunt economic growth and mis-allocate resources, when they guess to high they cause speculative bubbles and mis-allocate resources. When they guess just right they don't even know it, and basically just get lucky. The correct interest rate would arise naturally if banks set their rates at a market clearing level to match savings with loans. It's not that the people at the Fed are stupid for getting it wrong, it's that a cloistered group of bankers and economists will never allocate resources as efficiently as a market that incorporates real-time feedback on consumer preferences.
"Some of the anti-feds want to raise the reserve ratio to 100% for no apparent reason."
Probably because banks loaning money they don't actually have causes inflation and makes the whole financial system rather brittle. People who want a 100% reserve ratio generally want that for the same reason that they oppose printing new money and dumping it from helicopters.
I don't think we ought to have a reserve requirement at all, but I don't think we should stop banks from triggering runs on each other on purpose, so banks would avoid lending out all their reserves as a precaution.
Sorry, made the last post at work and has a sentence which makes no sense whatsoever.
ReplyDelete*When central planners guess too high they stunt economic growth and mis-allocate resources, when they guess too low they cause speculative bubbles and mis-allocate resources. When they guess just right they don't even know it, and basically just get lucky.
The required reserve ratio is only about 1.5 percent. Contrary to what we learned in Money and Banking, it is bank capital that constrains lending.
ReplyDeleteWith a RRR of 100 percent, banks wouldn't have the earning capacity to keep their lights on. Tis true that fractional reserve banking is inherently risky but it can be managed safely with good practices.
Ryan is right about the Fed's monetary tinkering. They can seldom even hit their fed funds target much less control money supply. We've been conned by both the Fed and government that they control levers and dials to fine-tune the economy. They collect exorbitant paychecks with little value added. They both have an important role - too bad they don't focus on that.
So the economists who have not been saying that everyone should understand accounting don't get any of the blame? I guess that makes sense since economists don't have to study accounting. ROLF
ReplyDeleteThe economy depends on consumers being dumber than economists.
The economists don't have to talk about the depreciation of the cars that the consumers went into debt for either. Would you believe $300,000,000,000 every year? What does that matter to the economy?
"With a RRR of 100 percent, banks wouldn't have the earning capacity to keep their lights on."
ReplyDeleteIf that's actually true, wouldn't that imply that banks shouldn't be in business in the first place? If the only way you can keep your business going is to spend more money than you actually have, to me that says that the business is a drain on the economy.
Now, I don't think it's actually true that banks couldn't afford to operate with a 100% reserve requirement. There probably wouldn't be as many of them, and the US financial sector probably wouldn't have gone from having 45 trillion in derivatives in 2001 to 170 trillion in derivatives in 2007. Granted those aren't adjusted for inflation or GDP growth, but holy shit 400% growth in six years? US net worth was less than 60 trillion in 2007.
Hopefully the current collapse will bring that crap back into line.
If a bank must keep 100% of deposits on hand, then how in the world are they going to earn money? Charging people money for holding their cash and clearing checks? Like I said, that wouldn't pay for basic costs.
ReplyDeleteWhere will they get the capital to make loans?
When banks lend money in a fractional reserve banking system, they CREATE money. This is not a drain but rather a source of growth.
Banks serve a much more important service than you think they do Ryan.
They don't merely lend money for houses, cars, and credit card purchase. They also provide loans for construction and development, up-front payments of workers comp and health insurance premiums for small businesses, and purchases of inventory.
Farmers use loans from banks to purchase seeds for planting, new equipment, and futures contracts on the goods the produce. Without those, they are subject to great price risk.
If businesses, farms, people, etc. all waited until they saved enough money for big ticket items, economic growth would grind to a halt. Borrowing provides the initial capital for production which creates jobs and profits.
Loans are intertemporal transfers of income and without them we have incomplete markets - a form of market failure. They can certainly be risky or abused, but that's what underwriting, due diligence, and credit ratings are all about.
Banks are indispensible, particularly in our sophisticated economy.
Derivatives are marvelous tools, but they must have their risks properly rated and priced. The problem is that they are often too sophisticated for purchasers to understand, including the "sophisticated" investors who really aren't as smart as they pretend to be.
"Where will they get the capital to make loans?"
ReplyDeleteVenture capital to get started, then the profits of their previous work.
"When banks lend money in a fractional reserve banking system, they CREATE money. This is not a drain but rather a source of growth."
Creating money from nothing doesn't create wealth, and it doesn't create sustainable growth. Increases in the amount of paper flying around can fool people who didn't expect the increase in cash into thinking that resources are more plentiful than they really are, but the increase in spending that follows this misinformation is neither sustainable nor desirable. Prices communicate information about the supply and demand of goods and resources, and increasing the money supply will distort that information so that real prices drop below the market clearing level in the short run before nominal prices adjust. If you want to argue that the price of capital defaults to a level above the market clearing price then maybe you could try to make a case for trying to fiddle with real prices by increasing the money supply based on that, but prices adjusting to a market clearing level in the long run is a pretty consistent feature of most markets.
"Banks serve a much more important service than you think they do Ryan.
They don't merely lend money for houses, cars, and credit card purchase. They also provide loans for construction and development, up-front payments of workers comp and health insurance premiums for small businesses, and purchases of inventory."
You say that like it's something I don't already know or agree with.
"If businesses, farms, people, etc. all waited until they saved enough money for big ticket items, economic growth would grind to a halt. Borrowing provides the initial capital for production which creates jobs and profits."
Banks creating money doesn't create capital, and like I already said, banks can make loans from their own capital and previous profits. Creating more money from nowhere just drives up prices and transfers purchasing power into the hands of the bank at the expense of everyone else who has a positive cash balance.
"Loans are intertemporal transfers of income and without them we have incomplete markets - a form of market failure. They can certainly be risky or abused, but that's what underwriting, due diligence, and credit ratings are all about.
Banks are indispensible, particularly in our sophisticated economy. "
Yeah, I know; loans are important. That's why companies are willing to pay a premium for liquidity now. That's also why banks can actually earn money and keep themselves in business without having to create money from nothing.
Ryan, I really don't understand what you're trying to say. It's contradictory.
ReplyDeleteBanks create money BY lending. They take in deposits, lend out almost all of it, and collect interest from the spread between the interest rate of money borrowed and money lent. The money multiplier is 1 divided by the required reserve ratio. if the RRR is 100%, they create no money.
Yes, banks creating money DOES create capital. Capital consists of the finished products used in production. For a pizza parlor, that would be the building, ovens, utensils, chairs, tables, refrigerators, sinks, pizza ingredients, etc.
When a bank lends money to an entrepreneur to start a business, they "create" capital by providing the funds to purchase it. This gets the ball rolling.
Lending does create capital. It does create wealth. It does create economic growth. It is sustainable. That's how we became the wealthiest nation on the planet.
But this is also inherently risky, which is why their lending practices must be regulated and confidence in the system must be maintained to prevent bank runs. As long as risks are diversifiable, there is no problem.
Banks HAVE NO previous profits under your system. They have no way to make money. A bank cannot accumulate assets for non-interest income if they don't make money from loans. And if they have a 100% RRR, they cannot make loans. Without interest, banks are bust.
Venture capital does not exist in sufficient quantities to keep the engine of our economy going. Sure, a group of 10 Chinese families might band together to help 1 person get started on their restaurant, but that doesn't happen often enough for economic growth.
Venture capital is also highly RISKY. Banks can mitigate that risk by spreading their interests over many different types of loans. VC cannot.
"Ryan, I really don't understand what you're trying to say. It's contradictory."
ReplyDeleteI'll take the first part of that sentence as explanation for the second.
"Banks create money BY lending. They take in deposits, lend out almost all of it, and collect interest from the spread between the interest rate of money borrowed and money lent. The money multiplier is 1 divided by the required reserve ratio. if the RRR is 100%, they create no money."
That's rather the point made by the folks who advocate a 100% reserve requirement.
"Yes, banks creating money DOES create capital. Capital consists of the finished products used in production. For a pizza parlor, that would be the building, ovens, utensils, chairs, tables, refrigerators, sinks, pizza ingredients, etc."
That's just wrong. Someone else makes those things. The bank provides liquidity that makes buying them easier, but no bank ever made an oven. Without money coming from nowhere, capital would still be produced and sold.
"When a bank lends money to an entrepreneur to start a business, they "create" capital by providing the funds to purchase it. This gets the ball rolling."
No. Printing more money doesn't create more capital. Only monetary cranks of the worst kind believe that this is so. As for the people who produce higher order goods, they price them at a level that clears. Banks producing money from nowhere drives up this price. Without the money coming from nowhere, the nominal cost of capital would be lower. The effect on real prices is harder to figure, since the price distortion caused by monetary injections is difficult to track but certainly doesn't hit the entire economy at the same time.
"Lending does create capital. It does create wealth. It does create economic growth. It is sustainable. That's how we became the wealthiest nation on the planet."
You're confusing lending with creating money from nothing. That's foolish.
"But this is also inherently risky, which is why their lending practices must be regulated and confidence in the system must be maintained to prevent bank runs. As long as risks are diversifiable, there is no problem."
Regulated by whom? The politicians? They're specialists in winning popularity contests, nothing more. A bank that makes bad decisions fails, while banks that make good decisions survive. A regulator that makes bad decisions causes the entire industry to fail at the same time, and they're no less prone to bad decisions than anyone else.
"Banks HAVE NO previous profits under your system. They have no way to make money."
Two problems there. First, it's not my system. I explicitly stated that I don't think there should be any sort of reserve requirement; I'm simply playing devil's advocate for those who do, since you didn't seem to understand their position. Second, they have profits from wise use of the money they started with. Whether that comes from a collection of Chinese families like you suggested or some sole entrepreneur who started from next to nothing, the point is that making loans only requires capital proportionate to the size of the loans you're making. Any school kid can loan another kid a buck for the snack machine and get paid back $1.10 the next day. The barriers to entry in financial services are artificially created.
"A bank cannot accumulate assets for non-interest income if they don't make money from loans."
They make money from loans. We've been over this.
"And if they have a 100% RRR, they cannot make loans. Without interest, banks are bust."
They can't make loans from their deposits, you mean. They can make loans from their previous profits, IPOs, or venture capital. Here's how it works: you find someone to give you money, through one of the above mentioned methods. You loan it out and make some profit, then you have more money you can loan out. In time you can pay back the initial investors, plus interest, of course. No, you can't start making huge loans the day after you open unless you can convince your investors to cough up a fortune, but that's one of the good things about a large reserve requirement. It keeps banks small-time until they've actually made real profits to prove that they're good enough to handle more money, and if a big bank screws up and loses money, their power to screw up in the future is reduced accordingly. People throw hundreds of billions of dollars into the stock market every year, but you're saying there's nobody to finance a bank trying to get off the ground; that it needs the power to create money from nothing to get the initial cash required. Really?
"Venture capital does not exist in sufficient quantities to keep the engine of our economy going."
With new money being flooded into the economy from banks, the price of capital goods is artificially inflated. But lets just ignore that for now; instead I'd like to ask you how much money do you think it takes to keep "the engine of our economy" going, and how much venture capital there is out there?
Here's a really, really fundamental economic principle that you seem to be completely missing: prices adjust to any supply of money. In the long run the aggregate supply curve is vertical. We don't need to produce more money from nowhere in order to have enough money to buy everything. Without new money flooding in, prices would just be lower. The only thing we'd lose is the underhanded looting of everyone else's purchasing power.
"Venture capital is also highly RISKY. Banks can mitigate that risk by spreading their interests over many different types of loans. VC cannot."
You're talking like you've never heard of venture capital funds. Investing in one startup is very risky; huge loss or huge reward. Investing in dozens of them in different industries works more like buying index funds, since the law of averages comes into play and your returns tend towards a more predictable average rather than being an all or nothing deal like they would be if you were just investing in a single company.