It seems the popular meme coming out of the right-wing media is to say that this whole thing is liberal government’s fault. They especially like to blame the Community Reinvestment Act (or CRA). Unfortunately, Seth echoed that meme in his last post, when he said “It acknowledges that federal policies (mostly liberal policies) are the cause of this mess.” The problem is, its not true, at least not completely. First, Tyler Cowen at Marginal Revolution, a very smart economistsays its not true.
This is one of the queries I receive, in varying forms, every day. Did policies such as the Community Reinvestment Act significantly worsen the housing bubble and the subsequent collapse? Basically not, although in my view these were bad policies for other reasons. They contributed to our current problems by only a small amount and of course these policies have been around for a long time before the housing bubble ever got started.
Another long and detailed debunking is HERE, The writer says:
Rhetoric aside, the argument turns on a simple question: In the current mortgage meltdown, did lenders approve bad loans to comply with CRA, or to make money?
The evidence strongly suggests the latter. First, consider timing. CRA was enacted in 1977. The sub-prime lending at the heart of the current crisis exploded a full quarter century later. In the mid-1990s, new CRA regulations and a wave of mergers led to a flurry of CRA activity, but, as noted by the New America Foundation’s Ellen Seidman (and by Harvard’s Joint Center), that activity “largely came to an end by 2001.” In late 2004, the Bush administration announced plans to sharply weaken CRA regulations, pulling small and mid-sized banks out from under the law’s toughest standards. Yet sub-prime lending continued, and even intensified — at the very time when activity under CRA had slowed and the law had weakened.
Second, it is hard to blame CRA for the mortgage meltdown when CRA doesn’t even apply to most of the loans that are behind it. As the University of Michigan’s Michael Barr points out, half of sub-prime loans came from those mortgage companies beyond the reach of CRA. A further 25 to 30 percent came from bank subsidiaries and affiliates, which come under CRA to varying degrees but not as fully as banks themselves. (With affiliates, banks can choose whether to count the loans.) Perhaps one in four sub-prime loans were made by the institutions fully governed by CRA.
Most important, the lenders subject to CRA have engaged in less, not more, of the most dangerous lending. Janet Yellen, president of the San Francisco Federal Reserve, offers the killer statistic: Independent mortgage companies, which are not covered by CRA, made high-priced loans at more than twice the rate of the banks and thrifts. With this in mind, Yellen specifically rejects the “tendency to conflate the current problems in the sub-prime market with CRA-motivated lending.? CRA, Yellen says, “has increased the volume of responsible lending to low- and moderate-income households.”
Now I want to say that the blame for this crisis can be spread around everywhere. Government and unregulated markets both. There is no doubt that the government “guaranteeing” so many mortgages encouraged risky behavior.
Here’s my much longer list of posts debunking the “blame the liberals and the CRA” crowd.
Andrew may not have heard, but there have been a few interesting developments in the financial markets over the last few weeks. As an economics blogger, I was regretfully forced to forgo full time devotion to the vice presidential race and turn to more trivial matters.
OUCH! Read the whole thing. Everything she says about the Palin nomination is spot on.
Sullivan’s obsession over Palin really is kind of sad and pitiful.
I like this article and wanted to make the following observations:
It acknowledges that federal policies (mostly liberal policies) are the cause of this mess. I know Steve and I have said that previously on fattriplets.com but here is a smarter man saying the same thing. (No offense Steve).
MONEY QUOTE - Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.
…
In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This “moral hazard” generates enormous distortions in an economy’s allocation of its financial resources.
…
Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.
And he makes the point that what ought to be done is that the stupid policies that caused this mess should be reversed.
The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.
…
So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.
Nevertheless, while the article acknowledges that things could get tough it is more optimistic than I am willing to be at this point about what happens if we do nothing.
The Democratic Party regains years or even decades worth of ground among the white working class, consolidates the Hispanic vote, and locks up a large chunk of highly-educated voters who might otherwise lean conservative. The much-discussed liberal realignment happens. And a politician running on a Ron Paul-style economic platform does very, very well in the GOP primaries of 2012.
Hmm. Maybe I should support Obama. Of course speculation like that is a little silly. But a guy can dream.
The best case scenario: The bad banks continue to be bought up, there is no run on hedge funds next Tuesday, only mid-sized European banks fail, money market funds keep on buying commercial paper, and the Fed and Treasury continue to operate on a case-by-case basis. Since Congress doesn’t have to vote for something called “a bailout,” it can give Paulson and Bernanke more operational freedom than they would have otherwise had. The American economy is in recession for two years and unemployment does not rise above eight or nine percent.
The worst case scenario: Credit markets freeze up within the next week and many businesses cannot meet their payrolls. Margin calls cannot be met and the NYSE shuts down for a week. Hardly anyone can get a mortgage so most home prices end up undefined rather than low. There is an emergency de facto nationalization of banks to keep the payments system moving. The Paulson plan is seen as a lost paradise. There is no one to buy up the busted hedge funds, so government and the taxpayer end up holding the bag. The quasi-nationalized banks are asked to serve political ends and it proves hard to recapitalize them in private hands. In the very worst case scenario, the Chinese bubble bursts too.
I still think some version of the best case scenario is more plausible, but I wish I could tell you I am sure.
I think this is a plan that makes sense. But I am afraid it is just not socialist enough for our friends in Congress. This Dave Ramsey article brings together many thoughts I have been reading elsewhere. Call your congressman.
Naked Capitalism posts a contribution from a former congressional staffer suggesting what some of the alternative possibilities for how the crisis could play out in Washington. What am I wishing for? I am hoping for # 4:
4) The process starts again, with new proposals and plans debated.
While this is perhaps the ideal situation, the likelihood of such an orderly debate will depend greatly on how the markets do in the next few days. If chaos continues to reign, the pressure will grow to pass something. This is where all those economists need to come together and come up with an alternate plan fast. While the University of Chicago writing a letter condemning the current plan was nice, it would have been better if they proposed an alternative. Remember that when a house is burning down, and someone proposes doing something, and another proposes doing nothing, chances are that something will win out, no matter how bad it is, simply because doing nothing is not an option.
Economists with ties to the Hill, or with journalists that could publicize such a plan, need to come together to propose a reasonable alternative. Throw enough academic credentials behind it, and they have a fighting chance of being more trustworthy than Bernanke and Paulson. We’ll see if the academic community which has been so vociferous in its criticisms can also make constructive proposals (It doesn’t have to have all the details in place, just remember 3 goals that can be reduced to soundbites for public consumption: save the financial system, punish Wall St., and cost less than $700 bil).
In all my reading about the bailout, I kept running across the term “moral hazard” and I realized I didn’t know what was meant by it. The Google to the rescue.
The possibility that a person may act dishonestly in an insurance transaction.
www.minnesotalife.com/about/glossary_pages/glossary_m.asp
anger of loss arising from the nature of the insured rather than from the physical nature of the risk. This would encompass those instances where the chance of loss is increased by an insured’s carelessness, incompetence, recklessness, indifference to loss or an insured’s fraudulent nature.
www.broker.ca/index.php/Glossary/M-N.html
The tendency of individuals, firms, and governments, once insured against some contingency, to behave so as to make that contingency more likely. …
www-personal.umich.edu/~alandear/glossary/m.html
Arises when people behave recklessly because they know they will be saved if things go wrong.
enbv.narod.ru/text/Econom/ib/str/261.html
The effect of personal reputation, character, associates, personal living habits, financial responsibility, and environment upon an individual’s general insurability.
www.farmers.com/FarmComm/glossary/glossaryM.jsp
A risk to an insurance company resulting from uncertainty about the honesty of the insured.
www.case.edu/med/epidbio/mphp439/Dictionary.htm
The impact that insurance, whether it is implicit or explicit (including lender-of-last-resort activity), may have in increasing the risks (or hazard) that investors may undertake in lending strategies.
www.booksites.net/download/mcaleese/student_files/glossary.html
A situation in which someone insured against risks will purposely engage in risky behavior, knowing that any costs incurred will be compensated by the insurer. …
www.wright.edu/~tdung/trade_glossary.htm
Occurs when a person can unexpectedly raise the costs to the health insurance company because the company cannot fully monitor the person’s behaviors.
daphne.palomar.edu/llee/BGlossary.doc
a condition by which an insured intends to profit from an insured loss.
www.patrons.com/html/body_glossary.html
Because insurance changes the costs of misfortune, insurance can change people’s behavior. They may make less effort to avoid misfortune; this is moral hazard. For example, if an accident costs a person $1,000 but insurance pays $800, the insured person has an incentive to avoid the accident. …
www.as.wvu.edu/wmst245/Handouts/FinanceConcepts.doc
Risk that an applicant for insurance will intentionally lie or conceal information that is pertinent to the policy.
www.foundationfinancialinc.com/glossary.htm
The tendency of agents who are insured to behave more recklessly because of their insurance cover.
wps.pearsoned.co.uk/wps/media/objects/2499/2559960/glossary/glossary.html
arises from the incentive of an agent holding an asset belonging to another person to endanger the value of that asset because the agent bears less than the full consequences of any loss.
www.uncdf.org/mfdl/workbook/pages/glossary.htm
The risk that a party to a transaction has not entered into a contract in good faith, has provided misleading information about its assets, liabilities, or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.
english.neftegaz.ru/info/dict/
A moral characteristic of an insured that may increase the likelihood of a loss, eg integrity, honesty, experience.
www.goguenchamplain.com/glossary.cfm
(economics) the lack of any incentive to guard against a risk when you are protected against it (as by insurance); “insurance companies are …
wordnet.princeton.edu/perl/webwn
Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. …
en.wikipedia.org/wiki/Moral hazard
Hazard arising from any nonphysical, personal characteristic of a risk that increases the possibility of loss or may intensify the severity of …
ask.inwiki.org/Insurance_Glossary_M
Our friend Buddy linked to this article in a comment. It is detailed and not encouraging. It was too good to merely leave in the comments. Thanks for the link Buddy.
PS…to read the article you will have to enter an email address…but if you really don’t like the idea I think a fake one will do. IMHO, this guy is smart enough to be on his mailing list.
I have a place where I put blog ideas and URLs I want to remember, and upon looking through that list I realized I had way more Palin links than I could ever blog on. So here is my dump of my Palin links.
No hurt feelings if you don’t click on even one. But this way I can clean up my BlogIdea list.
Noah Millman on Palin
http://theamericanscene.com/2008/09/17/songs-of-innocence-dirges-of-experience
Newsweek on Palin
http://www.newsweek.com/id/160080
Palin the Mean Girl
http://www.salon.com/news/feature/2008/09/23/palin/index.html
