Larry Summers and his role in recent US policy

by Chris Bertram on October 4, 2010

Charles Ferguson has a nice piece in the Chronicle of Higher Education about Larry Summers, the economics profession and their position in American public life. Definitely worth a read.

{ 114 comments }

1

AcademicLurker 10.04.10 at 5:13 pm

From the article:

“Summers is unquestionably brilliant, as all who have dealt with him, including myself, quickly realize.”

And yet he seems to screw up everything he touches. His “brilliance” seems to consist chiefly of the Right Sort of People repeating over and over again how brilliant he is.

2

Steve LaBonne 10.04.10 at 5:53 pm

And yet he seems to screw up everything he touches. His “brilliance” seems to consist chiefly of the Right Sort of People repeating over and over again how brilliant he is.

It’s exactly the kind of “brilliance” that has been repeatedly demonstrated by our Ivy League “meritocracy” as a whole. Superficial cleverness (masking deep ignorance), combined with the “right pedigree”.

3

Lemuel Pitkin 10.04.10 at 6:08 pm

His “brilliance” seems to consist chiefly of the Right Sort of People repeating over and over again how brilliant he is.

As usual in these parts, Dsquared said it first.

4

hhoran 10.04.10 at 6:51 pm

Ten years ago, Posner’s “Public Intellectuals: A Study of Decline” pointed out that the market for sophisticated intelectual analysis of public issues simply didn’t work, because there were no effective feedback mechanisms to reward good analysis and punish bad analysis. Posner pointed out that many public intellectuals were effectively paid by advocacy groups or established institutions, and not by the “public” or groups actually trying to solve difficult problems, thus intellectuals that fit their cultural/ideological bias were favored despite predictions and proposals that had been repeatedly discredited by subsequent events. Thus D-squared’s “echo chamber” reinforcement problem, and the problem that many “end users” are equally uninterested in developing policy solutions, and just want their biases and group loyalties affirmed.

Posner incorrectly predicted that the role of public intellectuals would continue to decline as he hadn’t foreseen the explosive growth of paid corporate advocacy groups, the increasing corporate domination of DC think tanks, cableTV news or internet blogs. All of which made the cultural/ideological bias and echo chamber/bias confirmation problems exponentially worse. But the underlying problems allowing folks like Summers (or Glen Beck or Thomas Friedman or scores of others) to prosper despite truly dismal track records aren’t new.

The problem with Friedman’s piece on Summers is that is isn’t at all clear whether he wants people to focus on the dismal track record/cultural bias within universities problem (a very long-term issue, mostly echoing Posner) or whether we should focus on the explosive growth of corporate funding and legal shifts–recent shifts making the echo chamber arguments more powerful and more immune from any counterattack, and creating much bigger impacts when these arguments are implemented.

5

BobbyV 10.04.10 at 7:58 pm

An economic forecaster is like a cross-eyed javelin thrower: they don’t win many accuracy contests, but they keep the crowd’s attention.
Anonymous

6

Akshay 10.04.10 at 8:13 pm

It reminds one of those other “brilliant” people with “a profound knowledge of geo-political strategy” who tend to recommend fighting land wars in Asia…

…And that reminds me of Eisenhower’s speech on the Military Industrial Complex. For Eisenhower did not only caution us against the MIC lobbying to fight useless wars. He also warned that “The prospect of domination of our nation’s scholars by Federal Employment, project allocations and the power of money is ever present.” I don’t think Eisenhower was thinking of the influence of corporate money on academic economics or medicine, more of the potential for a war on science carried out by political actors, but prescient it remains.

Anyway, interesting article by Ferguson. More Research Needed on the political economy of economics.

7

y81 10.04.10 at 9:06 pm

Prognosticators, elite and not-so-elite, are often wrong.
Members of the elite, unless they actually lose a war, usually get to keep their jobs and status.
If these two facts offend you, your life will be one endless disappointment.

Also: Most people, including without limitation Chris Bertram and Charles Ferguson, remember very well the faulty predictions of their opponents, but those of their allies not so well. I have learned to react to this fact with amusement, not irritation, which in turn reduced my need for whiskey at day’s end.

8

Uncle Kvetch 10.04.10 at 10:00 pm

His “brilliance” seems to consist chiefly of the Right Sort of People repeating over and over again how brilliant he is.

The Scalia Effect.

9

Mike G. 10.04.10 at 10:02 pm

“Members of the elite, unless they actually lose a war, usually get to keep their jobs and status.
If these two facts offend you, your life will be one endless disappointment.”

Imagine my dismay when I learned as an undergraduate that sociologists had come up for an even more disturbing (though related) principle: the Matthew Effect.

I suppose the Matthew Effect applies to social as well as financial capital.

10

Timothy Scriven 10.04.10 at 10:03 pm

The problem is, despite limited evidence that brilliance is correlated with competence, the conflation is yet made.

11

Mike G. 10.04.10 at 10:04 pm

*Come up with a term for

12

koshem Bos 10.05.10 at 2:46 am

Ferguson makes it appear as if Summers did it; that Summers was always wrong. That’s way too simple. It also is way too narrow. We started towards the almost depression long ago, at least from Reagan. Europe did the same and without Summers.

On the other hand brilliant is not well defined. Summers may be a brilliant economist, but he doesn’t seem to be very good at understanding Wall Street greed nor is he street wise. Those Summers’ drawbacks and below average human nature understanding made him a failure.

It’s way more complex than Summers and Rubin.

13

Jim Rose 10.05.10 at 3:09 am

Chris Bertram,
I think you fallen for a search for the man in the black hat – and no more than one or two – and an sexist bad guy would be even better.

Charles Ferguson’s upcoming film cannot have too many bad guys for the plot to be able to be followed on the big screen. Remember JFK: Stone could not decide which conspiracy was the real one so he presented them all, making for a crowded grassy knoll.

Charles Ferguson seems to have forgotten which Party controlled the White House between 2001 and 2009, and congress between 1994 and 2006.

If you are willing to open the door to blaming Clinton administration officials for our present discontents, do not complain what comes back to bit you when that door is opened to us all.

Giving a pass to Bush-Cheney when you have a chance to give them another kicking should be grounds for automatic expulsion from the Academic Left. What is your reason for being?

George Stigler had the view that economist had next to no influence over economic policy. Stigler argued that:
• when economists hold views congenial to an interest group, they become leaders of opinion; and
• When economists hold views inconvenient to interest groups, they become writers of letters to the editor of provincial newspapers.

A better analysis is in Ross Levine, 2010. “An Autopsy of the U.S. Financial System,” NBER Working Papers 15956.

Levine concludes that:
• the design, implementation, and maintenance of financial policies during the period from 1996 through 2006 were primary causes of the financial system’s demise;
• The evidence is inconsistent with the view that the collapse of the financial system was caused only by the popping of the housing bubble and the herding behavior of financiers rushing to create and market increasingly complex and questionable financial products;
• The evidence indicates that regulatory agencies were aware of the growing fragility of the financial system associated with their policies during the decade before the crisis and yet chose not to modify those policies;
• The New York Times warned in 1999 that Fannie Mae was taking on so much risk that an economic downturn could trigger a “rescue similar to that of the savings and loan industry in the 1980s,” and again emphasised this point in 2003; and
• Alan Greenspan testified before the Senate Banking Committee in 2004 that the increasingly large and risky Government Sponsored Enterprise portfolios could have enormously adverse ramifications.

14

Lemuel Pitkin 10.05.10 at 3:44 am

the design, implementation, and maintenance of financial policies during the period from 1996 through 2006 were primary causes of the financial system’s demise

I’m not sure how this is supposed to get Summers off the hook. Or did the policies design and implement themselves?

15

LFC 10.05.10 at 4:10 am

@y81 (comment 7 above): the Ferguson piece is not mainly about wrong predictions. It’s about, in large part, the close ties between (some) academic economists and corporations (including ‘financial services’ firms). It would be interesting to find out how many academic economists sit on corporate boards, take money from industry, give speeches to corporate groups, etc. Such activities are not automatically a sign of conflict of interest or corruption of judgment, but when someone can command $135,000 for a single speech to Goldman Sachs, one wonders whether the speaker doesn’t say to himself: “Hmm, perhaps I shouldn’t say anything that will really offend them. They might not ask me to speak again.”

In short, the issue is the uses to which ‘brilliance’ is put.

16

Jim Rose 10.05.10 at 4:44 am

Lemuel Pitkin,

blaming someone who does not hold elected office is a way of avoiding deciding who among those who held office and are still in office dropped the ball.

Bill Clinton is old hat, and bush-cheney is a too well-worn path, so a new bad guy was needed.

if you avoid blaming those in elected office, you do not have to do the hard yards and work out political solutions. Much easier to blame a courtier who is opinionated.

17

LFC 10.05.10 at 5:00 am

blaming someone who does not hold elected office is a way of avoiding deciding who among those who held office and are still in office dropped the ball.

H. Kissinger, as nat’l security adviser and secretary of state, did not hold elected office. I guess that absolves him of all blame/credit/responsibility for all aspects of US foreign policy in the Nixon and Ford administrations. Too bad that all the scholars who have wasted their professional lives writing thick tomes about Kissinger did not have the heads-up on this.

Ditto for Volcker and US economic policy in the late 70s. Etc, etc.

18

nnyhav 10.05.10 at 5:24 am

19

Josh 10.05.10 at 6:17 am

Since Ferguson, as is pointed out in the seventh (IIRC) comment on the CHE article, errs on such a basic issue as why Summers left the Harvard presidency, I’m not sure I want to take his word on other topics.

20

Jim Rose 10.05.10 at 6:25 am

LFC,

Kissinger was an agent of the president. he would not have lasted if he stepped out of tune. Nixon never struck me as someone who liked to surround himself with critics and threats to his power.

Volcker is a good example. He survived by doing what people wanted. Bring down inflation from double digits.

Fed chairs have a four year term, so not reappointing him, or promoting him mid-term to be Treasury secretary was always presidential options, as was done to his predecessor by Carter.

A lot can be explained about monetary policy by applying the usual models of bureaucratic behaviour. Using the real Fed Funds rate to measure monetary policy:

• Republican presidents and more conservative leadership of the Senate Banking Committee are significantly correlated with tighter monetary policy.

• Changes in the chair of the Fed are significantly correlated with changes in monetary policy.

Carter knew something about Volker when he nominated him. Reagan did not have to reappoint Volker. Volker was unpopular in 1983.

21

john c. halasz 10.05.10 at 6:43 am

@20:

Umm…. Volcker was re-appointed in the midst of the Volcker-Daemmerung, but not the next go-round. There was a vote passed before the end of his term on something called rule 23A (?), which significantly loosened regulations, such that, e.g., SIVs, CDOs, and auction-rate securities were all initiated immediately in the aftermath, but it passed 3 to 2 with Volcker opposing it. He was replaced by Greenspan precisely because he was a conservative strict regulationist.

22

Jim Rose 10.05.10 at 7:35 am

john c. halasz

given the choice between ferreting out a long forgotten rule change and looking at recent changes in monetary and housing policies that were popular just a few years ago, old obscurities wins every time.

Loose monetary policy that lowered interest rates to 1% and massive increases in government regulatory subsidies for the underwriting of housing loans for middle-class and emergent middle class constituencies can never be to blame.

A more compelling narrative would focus on the effect of over 25 million subprime and Alt-A (that is, nonprime) mortgages that are pervasive in the mortgage system in the United States.

These loans amounting to almost 50 percent of all mortgages and began defaulting at unprecedented rates in 2007. This caused the collapse of the asset-backed financing market in 2007as interest rates increased. The loss of the asset-backed securitisation market caused a huge reduction in financing that was available for businesses and consumers, precipitating the great recession.

Mortgage brokers cannot create and sell low quality mortgages unless they have buyers to underwrite them. Their main customers were government agencies or companies and banks required by various regulations to purchase these junk loans.

Blaming subprime and Alt-A mortgages on unregulated mortgage brokers must fail because the dominant role in creating the demand for and supply of the funds to make these deficient loans ever possible was the U.S. federal government.

The story from go to woe is government failure.

23

dsquared 10.05.10 at 7:48 am

I’m not sure how this is supposed to get Summers off the hook. Or did the policies design and implement themselves?

quite. In general, I usually emphasise that macroeconomic problems have macroeconomic causes and that most of these things are the result of much bigger trends that are related to the overall structure of the postwar capitalist system rather than individuals and their actions.

However, as Larry Summers has persuasively argued, even such a macro-oriented model needs to be given “microfoundations”, and, even if one believes that more or less anyone else in the same position would have done more or less the same, it is nonetheless good practice to allocate a significant amount of blame and opprobrium to the people who actually were in that place and that time, and who actually did fuck it up.

24

john c. halasz 10.05.10 at 8:09 am

Jim Rose:

Pure B.S. Blaming it all on the government and monetary policy, when it was largely the result of a de-regulated securitization “market” devised at Wall St.’s behest is not only in sheer bad faith, but in defiance of the overwhelming preponderance of the facts, (which, yes, I’m well familiar with, having followed these issues since long before the explicit outbreak of the crisis, though from a U.S.-centric perspective). And the “obscure” rule change was one of the beginning de-regulatory moves,- (and note the 3 items I indicated, of little significance then, but which sure came to roost in the end, eh?)-, which goes to the larger point that it wasn’t a matter of government failure, in accordance with your fact-distorting ideological proclivity, but of de-regulatory government capture. It wasn’t any government directive, but the securitization and derivatives apparatus of Wall St. Ponzi finance that blew the U.S. housing bubble, for all that political “authorities”, (cf. “the ownership society”), were fully complicit. Some of us have an actual attention-span, rather than being blinded by time-spanning ideological blindness.

25

Random lurker 10.05.10 at 8:41 am

The article speaks of famous academics. However I think there is a more general problem in economics: some chunks of the economic theory (say, for example, keynesianism) are not as spendable on the job market as others (say, for example, financial modeling) because most people won’t be employed as public policymakers or pundits but as employees of private firms.
As a consequence the “private business” side of economics tends IMHO to prevail on the “political economy” side on the academic market and, in the end, on the cultural stage at large.

26

Henri Vieuxtemps 10.05.10 at 9:12 am

…even if one believes that more or less anyone else in the same position would have done more or less the same, it is nonetheless good practice to allocate a significant amount of blame and opprobrium to the people who actually were in that place and that time, and who actually did fuck it up.

If indeed those “much bigger trends that are related to the overall structure of the postwar capitalist system” you mentioned are responsible for discovering and elevating right individuals to the right positions – then what’s the point of blaming and demonizing the tools? It’s a red herring.

27

Zamfir 10.05.10 at 10:02 am

then what’s the point of blaming and demonizing the tools?
Because it makes it more likely that people oppose the trend. Every big structural trend consists in the end of individuals, and the way to stop and reverse trends is to get enough individuals to dislike the trend.

The very last thing thing you should is saying “if you are part of the trend, no blame falls on you”. That would mean that joining the trend is always the safest place to be.

28

Jim Rose 10.05.10 at 10:12 am

john c. halasz, securitisation requires assets to securitise.

Explain why this bubble was different – the first bubble in 70 years to result in a world-wide recession. There have been 15 banking crises in the US since 1800, but only two – the 1930s crisis and this one – seeded a world-wide financial collapse.

The whole government mandated housing bubble was built on usually low interest rates – these rates are set by the Fed – and greatly expanded underwriting by Freddie and Fannie as the behest of Congress.

As of the end of 2008, of the over 25 million subprime and Alt-A mortgages:
• the Federal Housing Administration held 4.5 million subprime and Alt-A loans;
• Ten million were on the books of Fannie Mae and Freddie Mac – Fannie and Freddie actually bought most of the subprime and Alt-A mortgages sold in the US between 2005 and 2007; and
• 2.7 million are currently held by banks that purchased them under the requirements of the Community Reinvestment Act.

These 25 million subprime and Alt-A loans amount to almost 45 percent of all single family mortgages in the United States. Up to 1995, the homeownership rate in the US was a steady 64%. By 2000 it had risen to about 67.3%, and by 2004 it reached 69.2%.

In July 2005, when the Senate Banking Committee, then controlled by the Republicans, adopted tough regulatory legislation for the GSEs on a party-line vote–all Republicans in favor, all Democrats opposed. The bill would have established a new regulator for Fannie and Freddie and given it authority to ensure that they maintained adequate capital, properly managed their interest rate risk, had adequate liquidity and reserves, and controlled their asset and investment portfolio growth.

It takes 60 votes to cut off debate in the Senate, and the Republicans had only 55. In a 45 member Democratic caucus that included Obama, these votes could not be found.

Of late, Obama has taken to accusing others of representing special interests. Obama was the third largest Senate recipient of campaign donations from Fannie and Freddie.

The collapse of the housing bubble would not have sparked the great recession and credit crisis if the bubble had not been over-inflated by the low-quality loans required by government mandate that are now defaulting at unprecedented rates.

29

Tim Wilkinson 10.05.10 at 11:04 am

LFC @15 Such activities are not automatically a sign of conflict of interest

Actually, I think they exactly are; conflict of interest is a pretty objective matter of publicly observable facts (along with a few very general standing assumptions about what kind of interests people have).

Which is not just a quibble, because treating c. of i. as a more substantive and less presumptive matter constitutes a massive drop in in standards of probity.

For those who would prefer that c of i were never mentioned, or would like to able to wriggle out of it by demanding specific proof of the (near-) unprovable, or would like an excuse to meet mention of it with an aggressive counterattack, this low standard is very handy indeed. I think there’s a specific way in which conflict of interest falls down a gap in the way interests get declared, and that’s kind of seen as an end of the matter, unless anyone wants to start trying to prove some conspiracy theory (aka common-or-garden corruption and bias). There can’t be anything dodgy going on because it would have to be going on in plain sight, and that could never happen (pssst! as long as people aren’t convinced by this argument).

There’s a general question as to how high standards of public probity are to be maintained in a capitalist system in which all Walzerian spheres are subject to the money influence (I suspect they can’t really), but it would definitely be better if they could be. Getting rid of anyone who is so much more interested in accumulation of money than in contributing to the fund of human knowledge would be a wonderful thing, one would think.

(The same mutatis mutandis goes for many other areas, notably politics, contrary to the ‘we must pay more to attract the best’ kind of argument. I very much doubt that in many fields there really is a small class of candidates so far ahead of the pack in ability rather than luck. But even if there were, the argument leaves out of account the fact that being greedy and superficial merits a significant marking-down of just how good the candidate is.)

30

Henri Vieuxtemps 10.05.10 at 1:33 pm

@27, Because it makes it more likely that people oppose the trend. Every big structural trend consists in the end of individuals, and the way to stop and reverse trends is to get enough individuals to dislike the trend

I’m afraid that demonizing tools produces the opposite effect. If this is Summers’ fault (even if only partially), then let’s send a better person there! Elizabeth Warren! And Paul Krugman! Let’s vote for Obama, because he is a smart and nice person.

Well, it’s not going to work. You need to talk more about the trends, and less about individuals.

31

LFC 10.05.10 at 1:42 pm

Tim Wilkinson @29: I understand your point about presuming c. of i. when certain observable facts are present, and this may indeed be the better approach, at least in some contexts. (More to be said here, but I will leave it to those who have thought more about this than I have.)

32

Castorp 10.05.10 at 2:11 pm

I agree that Larry Summers’ role in the financial crisis cannot simply be dismissed, but some of the causation here is weak:

“As a rising economist at Harvard and at the World Bank, Summers argued for privatization and deregulation in many domains, including finance.”

Yup, like most economists then. I bet you wouldn’t even have gotten much of an argument from Krugman at the time (though I’m not sure and would love to be proved wrong). As a reminder of the climate of the Washington Consensus at the time think back to when Krugman was pilloried by economists and the press etc. when he stated the obvious during the Asian financial crisis that capital controls, might, you know, make sense?

“…Summers oversaw passage of the Gramm-Leach-Bliley Act, which repealed Glass-Steagall, permitted the previously illegal merger that created Citigroup, and allowed further consolidation in the financial sector.”

He “oversaw” it? Surely Gramm et al were responsible for pushing the legislation and Democrats like Shumer etc contributed their fair share.

“He then oversaw passage of the Commodity Futures Modernization Act, which banned all regulation of derivatives, including exempting them from state antigambling laws.”

Same thing. Now you can argue that as Treasury Secretary he could have opposed these things and convinced the President to veto them, and I’d be happy to hear you out. But it seems more plausible to me that the neo-liberal ideology that took hold in the economics profession, combined with a rightward lurch in economic policy and activism in this area in the Republican and to a somewhat smaller extent the Democratic parties due to collapsing unions the business community’s and especially the finance industry’s lobbying efforts etc. created the ground for all of this. If the political landscape had been different Larry Summers either would have had other beliefs or someone else would have been there implementing and advocating policy in the Treasury. I do think it is fair to argue that considering Summers’ previous work Obama should not have brought him to the White House and that a real opportunity was missed to reform (as much as is possible) the financial industry when it was at its weakest and needed to be bailed out. But that is another story.

33

john c. halasz 10.05.10 at 5:33 pm

Jim Rose:

This is probably not the thread on which to pursue this topic, as it’s not on topic and U.S.-centric. But you’re pursuing Austrian ideological piffle: the free market fails only because it is never free enough, therefore its dysfunctions and failures must all be the fault of government interference and policy failures. (Cf. the work of Joseph Stiglitz on just how potentially pervasive market failures are). But it’s clear you don’t understand what’s involved in structured securitization, (whereas GSE bonds are unstructured pass-throughs), that the GSEs had been caught up in a derivatives accounting scandal and restricted in their operations, so that private-label securitizations took over the lion’s share of the market, whereas GSE bonds only involve “conforming” morgages which were not the main locus of the crisis, (with their subprime portfolio only being a side business and purchased from Wall St.), that the GSE collapsed after being pushed by the government to take over more risk from an already collapsing housing/mortgage market, and now comprise 90-95% of the extant market, that CRA was not the source of the subprime boom, (only 16% of the total mortgage issuance), since most subprime origination came from non-covered lending “platforms”, etc.

If you’re saying that bad public policy all too complicit with “free market” interests were partly to blame for the immense dysfunction of the U.S. economy in the naughties, I’d be inclined to agree. But if you’re claiming that no alternative public policy regime could have been implemented that would have avoided the crisis, then you’re just question begging. Not to mention the larger and longer-term global context in which eventually gave rise to the U.S. sponsored GFC.

34

bianca steele 10.05.10 at 6:00 pm

Tin Wilkinson @ 29: You’re not using the definition of “conspiracy theory” most people use. Corruption and conspiracy theory are two thoroughly different kinds of historical explanation.

Jim Rose @ 20: No. LFC is right on this. Kissinger did what his employers could not and perhaps would not. That is the definition of a superstar employee.

35

bjk 10.05.10 at 6:48 pm

Three keys to being considered brilliant: a) cut your academic career short and publish little, b) lack good judgment, and c) be involved in an ambitious and catastrophic failure demonstrating a complete lack of good sense, and d) be identified with a large, all-explanatory theory (eg, efficient markets, fourth wave of democracy, realism, etc.)

From this we can conclude that “brilliant” actually means “an arrogant Phd lacking in ordinary good judgment.” This fits Kissinger, Wolfowitz, and Summers, who are all regularly considered brilliant. Brzezinski has a Phd but is not considered brilliant because he fails on b) and c) and d).

36

Tim Wilkinson 10.05.10 at 6:59 pm

bianca: Better try to avoid a lengthy threadjack, but: there is use, and there is definition. And in the case of ‘CT’ neither is very consistent and the two are not closely aligned one with the other. This is exactly the kind of situation in which the term CT would be used – to fend off a reasonable accusation (which can be described as a CT on an expansive, reasonably face-value meaning of the term) by implicitly bracketing it with stereotypical loony stuff.

I was using it ironically to refer to this kind of tactic, but in fact if it were not for the sneakily pejorative use of the term, it would not be unreasonable to use the it in these circumstance, since there is no clear distinction in kind separating conspiracy from corruption. The main difference is perhaps in the degree of specific, conscious and explicit planning – but that is not a salient distinction, nor an apt one – there are commonly very mixed mechanisms involved in both conspiracy and corruption.

And conspiracy theories – on any reasonable understanding of the term – are not a special mode of explanation, any more than anything else is,nor need they perform an explanatory function in pragmatic terms. Popper and Hofstadter are to blame for some very badly mistaken (or at least as plausibly, dishonest) ideas about this that have – amazingly – only recently been explicitly exposed as such in the philosophical literature. I have done some lengthy droning on about this stuff on CT before.

37

john c. halasz 10.05.10 at 7:33 pm

“nor need they perform an explanatory function in pragmatic terms.”

I’m not quite sure what that means. There are pure explanations without any pragmatic implications? There are explanations that are especially pragmatic? Entirely oriented by an interest in direct and successful action? Vs. sheer contemplation of faillible, fallen humanity?

At any rate, it used to be an old Marxian saw that there is no need to appeal to any explanation via conspiracy, since the systemic orchestrations of capitalism would achieve the same result far more efficiently and extensively than any conspiracy possibly could. (Of course, that depends on just how organized or disorganized or generally chaotic one thinks such a system is).

38

Geoffrey 10.05.10 at 8:47 pm

I do not think Ferguson’s article makes Summers out to be the villain in the black hat. I think the article points out the way moving from academia to corporate chair to government office and back again is not dependent upon the actual outcome of policies for which individuals advocate and implement. Rather, having reached the stature which allows for this to happen insulates individuals from accountability. Not only because cronies and acquaintances and colleagues share the same general ideology, but also because there seems to be an implicit assumption that membership in this elite group insulates one from the larger consequences of acts done in an official capacity.

I do not think Ferguson sees Summers as the villain. Rather, Summers is offered up, in this article, as an example of a larger (but still relatively small) cohort of individuals who, despite working on different sides of the party-political fence nevertheless shared certain assumptions and biases. They worked to implement policies rooted in these biases and assumptions. When they turned out to be catastrophically wrong, the cohort looked at one another, scratched the back of their heads, chuckled and said, in effect, “Oops.”

It’s an entire system that sees does not need to define “brilliance” because achievement of a certain rank and station is an indicator of brilliance. There is no more an accountability for that epithet than there is for the results of implementing policies that nearly bring down the entire financial system of the western world.

39

John Quiggin 10.05.10 at 8:55 pm

An economist could[1] point to the numbers in Ferguson’s piece as evidence of how hard it is to corrupt economists. It takes 135k to buy Larry Summers for a single speech. By contrast, the tobacco lobby could, and did, buy Roger Scruton, also routinely described as “brilliant”, for a whole year at the same price.

fn1. But, I have a fine counter-argument ready to go if someone else doesn’t make it first.

40

djw 10.05.10 at 8:59 pm

“This fits Kissinger, Wolfowitz, and Summers, who are all regularly considered brilliant.”

Also Condi Rice.

41

LFC 10.05.10 at 9:17 pm

Pedantic footnote re Kissinger (see bjk @35): he actually published a fair bit before leaving academia, including A World Restored (based on his Ph.D. diss.) and Nuclear Weapons and Foreign Policy (1957), the latter perhaps chiefly remembered for its toying (as others also were at the time) with the idea of a limited nuclear war which he later, IIRC, retreated from.

OK, back to Summers and economists…

42

Barry 10.05.10 at 9:52 pm

djw: “Also Condi Rice.”

I’m sure that that Stanford maggot will crawl back out of the Hoover cesspool and into the next GOP administration.

43

Matt 10.05.10 at 11:08 pm

Also Condi Rice

Do/did people consider her “brilliant”? That’s not been my impression at all. I’m sure some of that is prejudice, but also, her lack of brilliance.

I’d argue that Brzezinski showed some pretty bad judgment in some of the decisions in the Carter administration he supported- Afghanistan, Iran, etc., and that this lead to some catastrophic, if slow developing, failures, and that his sort of anti-communism was an attempt at a big idea that was mistaken in some pretty serious ways, even if not as serious as those of, say Kissinger.

44

Robert 10.06.10 at 12:04 am

John Quiggin’s “argument” is purely a fallacy, that is, tu quoque. It is impossible to violate the American Economics Association’s (AEA’s) code of ethics. They don’t have one.

45

Jim Rose 10.06.10 at 12:21 am

John Quiggin.
It is not necessary to buy a viewpoint if they are already there ready and waiting.

For example, politicians and interest groups know there is always a few Keynesian macroeconomists out there to be hired to defend their plans to spend up big. These Keynesian macroeconomists will be giving their honest long-time beliefs.

When fiscal discipline is in vogue, hire a different set of economists who believe with equal fervour in what is now required.

Stigler a long time ago pointed out that the canons of economics and conflicting empirical evidence allow a wide range of viewpoints.

For example, market socialists such as Lerner and Lange made arguments that had to be answered and provoked a much more fruitful debate and deeper thinking on the subject by those they disagreed with,

46

Tom Hurka 10.06.10 at 3:30 am

Who describes Roger Scruton as “brilliant”?

47

John Quiggin 10.06.10 at 4:22 am

48

Jim Rose 10.06.10 at 6:31 am

John Quiggin,
On Roger Scruton, I suppose that economists and philosophers who call for the decriminalisation of marijuana are equally bought and paid for? They too are enemies of the Nanny state.

Some want to tax sin; others want to ban it.

You do not have to approve of other’s vices to suggest that people should be able to pursue their vices as long as they do not harm others. These same supposedly short-sighted sinners/smokers are deemed competent to vote and drive cars. Would you vote for a smoker? is’nt smoking evidence of a lack of foresight and self-control?

Excise taxes on cigarettes are regressive and whose burden falls more heavily on the poor than on the rich. Marijuana consumption increases when beer or cigarette taxes are increased or the minimum drinking or smoking ages are raised.

Roger Scruton criticised the WHO for focusing on tobacco instead of vaccination campaigns and diseases. This is a fair difference of opinion over priority.

In the least developed countries, when life expectancies get to be long enough that many might live long enough to start to die in large numbers from tobacco related illnesses, smoking might be a major public health issue.

I hope the WHO is spending nothing on anti-tobacco education in Aids ravage countries such as in Africa. They have more important things to do. Do you agree?

How much does the South African Health ministry spend on anti-smoking issues as compared to combating Aids? The South African Government banned smoking in all the stadiums in World Cup games. Was their Aids-denier of a President the patron of the whole anti-smoking show?

As an aside, if income taxes do not have significant disincentive effects – a core Left-Wing belief – why would higher sin taxes do a better job of reducing the consumption of addictive goods such as tobacco?

49

Chris Bertram 10.06.10 at 6:37 am

If it is in the Guardian it must be true! A difference, surely, is the Scruton suffered a considerable reputational hit (people laughed at him even more than before), whereas Summers just carries on in and out of the revolving door.

(If anyone wants to buy me for a whole year, £135k will do nicely!)

Incidentally, Jim Rose, the “officials are only following orders from politicians” line, would not look plausible to anyone who had watched a few episodes of “Yes Minister”.

50

Chris Bertram 10.06.10 at 6:46 am

(Note to Jim Rose: you’ve posted 85 comments on CT since mid-September and just under 40 since last week, many of considerable length. We are relatively (over)indulgent towards our ideological adversaries here at CT, but we do need to prevent individuals from dominating discussions. So (much) shorter comments and fewer of them please (max 2 per thread per day.)

51

Jim Rose 10.06.10 at 7:38 am

Chris Bertram , thanks

a good book on this subject is cass sunstein’s Republic.com 2.0

He talks about how people are using the Internet, especially the blogosphere, and goes on to warn against information cocoons and echo chambers, wherein people avoid the news and opinions that they don’t want to hear.

52

Tim Wilkinson 10.06.10 at 10:55 am

jch @37: “nor need they perform an explanatory function in pragmatic terms.” the distinction was meant to be between (1) a logical explanation relation between two propositions and (2) the answering of a ‘why’ question. Any conspiracy theory will enter into the former with any number of other propositions, without necessarily figuring in any instance of the latter.

BTW – re ##29, 34, 36 on ‘conspiracy theories’ – I hadn’t noticed before, but scrolling down the page, I noticed that one of Jim Rose’s (@13) mentions the word ‘conspiracy’: a closer look at the surrounding wordage revealed a sneering comparison with JFK (the film) and the suggestion that this was all about looking for scapegoats by means of a fact-insensitive construction of explanatory theories.

What it is actually about of course is some extremely dodgy behaviour, which no amount of bleating about black-hatted villains, conspiranoia and wider events is going to make go away. A fine example of the conspiracy-theory smear tactic though.

53

burritoboy 10.06.10 at 1:26 pm

To return to the topic of conversation, I (unlike the rest of the commentators) assert the two following claims:

1. Larry Summers, as an academic economist, is indeed brilliant.

2. Larry Summers, as a policy-maker and decision-maker, has not proved successful.

These two things are not paradoxical – Summers has at least two character traits that might simultaneously make him a great economist and flawed in other roles.

One is Summers’ arrogance and self-confidence. Another is an unexplainable inability to reconcile his own academic work with economic policy making – i.e, Larry’s own papers are perhaps the most important arguments against his own practical policy-making.

54

dsquared 10.06.10 at 1:33 pm

Another is an unexplainable inability to reconcile his own academic work with economic policy making – i.e, Larry’s own papers are perhaps the most important arguments against his own practical policy-making.

I think that TW at least regards it as all too easily explainable.

55

Henry 10.06.10 at 7:14 pm

>Also Condi Rice

From Benjamin Cohen’s history of IPE (p.25)

bq. Another time, I witnessed [Robert Keohane] serve as a discussant for a research paper presented by a young woman just out of graduate school. Not impressed by her scholarship, Keohane tore her work to shreds, questioning her understanding of basic IR theory. I left the room thinking that the young woman’s career was over before it had begun. She had the memorable name of Condoleezza Rice.

56

burritoboy 10.06.10 at 7:14 pm

“Larry Summers, as a white-collar criminal, is indeed brilliant, as like the Rothschilds were brilliant.”

No, Summers is a brilliant economist, regardless of the non-brilliance of his other activity. The Noise Trading article alone is one of the most important papers in recent years. It’s almost as important as Debreu-Sonnenchein-Mantel.

57

Tim Wilkinson 10.06.10 at 10:02 pm

dsquared@55 I think that TW at least regards it as all too easily explainable.

It would appear so, though I’m more concerned with generalities and leave the hard work of investigation to others. Conspiratorial and quasi-consp’l accounts can of course explain – it’s just that they need not, and often don’t, arise from a search for explanations of other events, still less from prejudgement of what any such explanation must involve.

For all I’ve said, Summers need not have actually done any conspiring (not even solo ‘conspiring’ – more than one person’s being involved has no very salient significance here). Nonetheless, the conflict of interest is substantially dodgy. The price (opportunity cost) of authority is, or ought to be, avoiding objective motive for corruption. Whether the motive motivates is a further question. That question goes beyond conflict of interest, which does not involve a presumption of ordinary wrongdoing, and is thus not rebutted by proof that no such wrongdoing has occurred. Neither is it in the way of being a legal fiction, an irrebuttable assumption, that such ordinary wrongdoing has actually happened – that would just be silly. It belongs to the sui generis category of professional misconduct.

Personally, I’m satisfied that the ‘higher’ echelons of the economics profession are riddled with corruption – and as with most quasi-conspiratorial situations, this involves both entirely situational factors (like selection and self-selection) and conscious manipulation, as well as all the fine gradations of self-deception, hypocrisy and bias. Situational factors of course may be consciously designed, maintained or tuned (cf Hayek, tRTS, ‘good’ planning is designing clockwork institutions in which competition will operate), while conscious design may for all I know, and pace KM, be determined by the forces of production or what-have-you.

And I’m pretty sure that this Summers character’s reported activities are a part of that corruption. If burritoboy is right about the mismatch between S’s academic and policy positions, that would appear to be apt for explanation. And the independently observed facts about what S has been up to would probably feature pretty heavily in such an explanation.

(BTW, comment 23 below the Chronicle article:
vituperative conspiracy mongering… sure, they had conflicts on interest that probably influenced their views…hysterics about the evil machinations of Summers, Geithner, and Rubin…a scapegoat that everyone hates anyway: rich, Jewish bankers… emerging narrative, of shifty hypocritical bankers controlling the economy from behind the scenes, is an old one with a grisly history, and it never leads anywhere good. Keywords: conspiracy-mongering, hysterics, machinations, scapegoat, Jewish, controlling, grisly history)

58

john c. halasz 10.07.10 at 1:13 am

TW @ 53:

Not to feed your pet obsession too much, (not that I disagree with it, in terms of distinguishing between conspiracy theories and “conspiracy theories”, and the apologetic function of the conflation of the two), but by way of further clarification. I take it you’re saying that non-dubious functional orchestrations that amount to apparent “conspiracies” can be objectively identified and described without resort to special conditions or hidden mechanisms. (I have a bit of trouble with the notion that any explanation can avoid some sort of “why” question motivating the explanatory endeavor. But in this sort of case, we’re dealing with an explanation in terms of (systems of) social action, so the identification of intentions, structures and conditions of variously distributed agents or agencies enters into the “equation”, no?). But some sort of goal-state, if only on a systemic and not a personal level, must be involved in the identification and explanation-or-description of such a “conspiracy”, in logical and “causal” terms, else it can’t be clear whatever is being talked about. And, on the other hand, “corruption”, even if licit, is a normative term, imputes some sort of standard, together with deviations and duplicity with respect to it.

To give an example of what I think you’re getting at, Madoff et alia was a narrowly held Ponzi scheme, which required highly restricted access or secrecy among a sharply limited number of confederates to maintain the dysfunctional or destructive results of such activity by means of a contrary deceptive appearance. But the Wall St. machinery of structured securitization was an open-air Ponzi market, in Minsky’s sense, which involved much fraudulent and predatory behavior. even though apparently perfectly legal, among distributed agents and agencies, which many of the more savvy must have been fully aware of, but which didn’t involve any closed coordination among a select group to maintain a covert deception.

Another way to make the sort of distinction I think you’re trying to get at, is that an excessive obsession with ad hominem criticism and the corresponding seeking after hidden motives is largely beside the point for any “conspiracy” that generally matters. Since motives, as opposed to the identification of acts, intentions, structural constraints and conditions, are simply inferences from the aforementioned and never in any sense objectively in evidence, a basically paranoid obsession with hidden motives, though in particular cases such motives might be operative, adds nothing to the general case, and is neither sufficient nor necessary for the identification and explanation of a “conspiratorial” effect, though the conflation of the two cases, such that all such all such imputations reduce to the explicitly paranoid instance, is itself obfuscatory to apologetic effect.

On the other hand, to return to the general topic of the thread, I’m sure you’re familiar enough with economic discourse to know that there’s more than one way to skin a cat, and that economists routinely make numerous different arguments based on the same or different models, often to my sensibilities quite sophistically, to bewildering and contradictory effect. So there’s an issue of fundamental uncertainty and dreaded relativism involved, which economic theory per se, with its “rigorous” distinction between the normative and the positive, can’t resolve. The likes of Larry Summers makes his way to “brilliance” by the utter confidence of his argumentativeness, by which he can evade the sort of accountability that one might otherwise expect.

59

Landru 10.07.10 at 1:45 am

Perhaps those here who know more of the ins and outs of academic hiring can supply an answer to this question, following the article: Why would academic ranking be so correlated with putting one’s credibility out for rental?

Do selective departments tend to hire, tenure and promote the kind of people who can be bought/rented to write what a rich patron wants? If so, isn’t that a mistake? wouldn’t it have been the goal to hire & promote someone with intellectual integrity? Why, if the article is to be believed, do highly-ranked departments which have a wide choice of faculty seem to keep making this mistake over and over?

60

Jack Strocchi 10.07.10 at 3:56 am

Pr Q @ < hrf="http://crkdtmbr.rg/2010/10/04/lrry-smmrs-nd-hs-rl-n-rcnt-s-plcy/cmmnt-pg-2/#cmmnt-334035" rl="nfllw">#39 sd, thrd tm prprly tggd:

<>n cnmst cld[1] pnt t th nmbrs n Frgsn’s pc s vdnc f hw hrd t s t crrpt cnmsts.

<>fn1. Bt, hv fn cntr-rgmnt rdy t g f smn ls dsn’t mk t frst.

n “cnmst” prfssn tht knws “th prc f vrythng nd th vl f nthng.”

61

Jack Strocchi 10.07.10 at 5:47 am

< hrf="http://chrncl.cm/rtcl/Lrry-Smmrsth/124790/" rl="nfllw">Chrls Frgsn sd:

<>rrly hs n ndvdl [Smmrs] <>mbdd s mch f wht s wrng wth cnmcs, wth cdm, nd ndd wth th mrcn cnmy.

Fr ld tms sk, lts < hrf="http://www.tm.cm/tm/cvrs/0,16641,19990215,00.html" rl="nfllw">svr th cvr f Tm mgzn bck n 1999, wth pctrs f Grnspn, Smmrs nd Rbn nd cptnd “th cmmtt t sv th wrld” strng smgly t f th scrn. Lk gng f rsnsts psng s fr-fghtrs.

n cnmcs vr th pst gnrtn, “th smrtst gys n th rm” hv bn th strngst prpnnts f fnncl lbrlstn. Nt jst Smmrs nd Rbn, bt Schs nd f crs Shlfr [1]. Y knw n thng thy ll hv n cmmn, yp, thy ll wnt t Hrvrd.

nd f crs fnncl mrkts thmslvs hv fmsly bn stffd by (x-)rckt scntsts. Qnts lk Blmbrg, Srs, Smns, Mrtn, Schls hv grnrd hgh cdmc wrds s wll s gzllns f dllrs.

Nt cntnt wth prfssnl sccss thy hv ll gn nt bggr nd bttr thngs s pltcl rchtcts. ccrss th glb, frm th md-ghts thrgh md-nnts, fnncl lbrlstn hs bn pshd by Hrvrd-dctd nd cnmsts.

Whr hs mplyng ll tht brn pwr t th hghst lvl gt th stts tht hv mbrcd ths phlsphy? Nr bnkrpt, thts whr.

Bth Sprpwrs hv bn sbstntlly pllgd by bth fnncl lbrlstn. (Rss’s fnncl shck thrpy ws bvsly mr rdcl nd thrfr mr shckng.) Wth lgrchs/gldd g pltcrts rkng n th lns shr f ny prdctvty gns md vr th pst gnrtn.

S “fnnclztn” [2] mngd t chv wht tw gnrtns f mltrstn nd wrfr dd nt: brng th Sprpwrs dwn n thr cps. Yt w stll hv ths fnncl prsts nd prdtrs n pwr bsrbng mr thn 10% f ntnl ncm fr th prvlg f thrwng spnnr n th wrks f ppl wh hv rl jbs.

Bt thts pst-mdrn lbrlsm fr y, “th scndl s nt whts crmnl, ts whts lgl”.

[1] ndr Shlfr s th wrld’s mst ctd cnmst. ts sf t sy tht n prvtsng schm wrth ts slt wll fl t qt rn n dfnc f th ndfnsbl. Th fct tht Shlfr hlpd t wrck th Rssn cnmy nd ws fnd t b crrpt by hs Hrvrd lm mtr hs dn n dmg t ll t hs cdmc rpttn, whch kps gng frm strngth t strngth.

[2] FWW ws th frst prsn n th blgsphr t s th trm “fnnclztn” < hrf="http://jhnqggn.cm/ndx.php/rchvs/2003/06/07/wknd-ntglblsm/#cmmnt-7500" rl="nfllw">wy bck n 2003. lthgh my sggstn tht “prg” ws ndd t cln hs hsnt cght n.

62

musical mountaineer 10.07.10 at 7:32 am

The collapse of the housing bubble would not have sparked the great recession and credit crisis if the bubble had not been over-inflated by the low-quality loans required by government mandate that are now defaulting at unprecedented rates.

Well, I’m glad somebody said it. You can cry about “deregulation” of derivatives all you want, but if not for some very heavy-handed government interference in real-estate finance, there never would have been any bait in the trap for those horrible capitalists. Anybody care to explain how derivatives would have crashed the economy if the underlying debt was good?

Halasz came closest to answering:

you’re pursuing Austrian ideological piffle: the free market fails only because it is never free enough, therefore its dysfunctions and failures must all be the fault of government interference and policy failures

That’s a generalization which doesn’t address the specific argument. No surprise, since the specific argument is unanswerable. No wonder Chris told that guy to shut up.

I personally am not ideologically committed enough to have much need for “always” or “never”. There’s plenty of blame to go around, I’d guess. But free markets, while they are far from perfectly rational, do have strong incentives to correctly assess debt risks. When a .gov applies artificial downward pressure to that assessment, the actions which result are almost by definition less rational. This is true even if the .gov has a noble progressive intention, such as getting more people to own their own homes. Some people can (ahem) never admit that noble progressive intentions may contribute mightily to bad outcomes.

I have no opinion on whether any of this tends to vindicate Larry Summers.

63

maidhc 10.07.10 at 8:10 am

Doesn’t the same thing happen in lots of different areas?

On a vulgar level I remember the National Enquirer running the late Jeanne Dixon’s predictions for the coming year every January—it was usually about space aliens making contact, Elvis returning from the dead and so on. Every year! You’d think people would remember back to the previous January and get a little skeptical about the space aliens not showing up, but I guess it sold National Enquirers, so they kept on doing it.

Then there are artificial intelligence proponents, who have been predicting that intelligent computers will arrive 30 years from now since the 1950s. I noticed Marvin Minsky still on the go just recently. This is the same Marvin Minsky whose predictions about computing in the year 2001 were prominently featured in the movie 2001: A Space Odyssey.

Futurologists in general seem to be immune to any kind of memory-based rating system. Dude, where’s my flying car? Where’s that 3-hour work week because robots will do everything for us? Where’s the biggest problem in the 21st century will be what to do with all our free time?

I lump it all together in the category “nice work if you can get it”.

64

Henri Vieuxtemps 10.07.10 at 8:10 am

But free markets, while they are far from perfectly rational, do have strong incentives to correctly assess debt risks.

How so? I’m not sure what “free markets” is, but if I own a rating agency and some powerful financial institution offers me a very large (and not quite illegal) bribe to give a higher ratings to some complicated securities, what is my incentive to reject the offer?

65

ajay 10.07.10 at 10:09 am

Henri: in theory, your incentive is to preserve the reputation of your rating agency as being an honest, critical provider of opinions. If it becomes generally known that either a) you tend to give much more generous ratings than your rivals or b) that you do so in return for big additional payments, then the market will regard a high rating from Vieuxtemps Credit Ratings as worthless, and so no one who wants to sell a product will waste their money on paying you for one. They’ll go down the road to Wilkinson Credit Research, because the market knows that a Wilkinson AAA rating is a reliable mark of quality, whereas a Vieuxtemps AAA just means the structuring bank paid you off.

In theory.

Obviously it doesn’t quite work that way in practice for reasons I can go into if needed.

66

Tim Wilkinson 10.07.10 at 10:13 am

Beauregard @63: I don’t understand what you mean by ‘conspiracy accommodation’. Dismissing people on spurious and lurid pretexts like that is something I specifically oppose, strenuously, consistently and publicly. The string of quoted extracts was intended as an illustration of that very tendency, and not as an endorsement, if that has caused any confusion.

FWIW, I’m not sure I have the evidence at my fingertips to agree that in the case of Summers the facts don’t merely suggest conflict of interest but like serious crimes, market manipulation, insider deals, etc, except on a pretty weak sense of ‘suggest’. But I would certainly be unsurprised, I mean that’s business as usual isn’t it. One of my points was that the charge of conflict of interest stands without the need to get into the further details of the actual foul play involved – it was certainly not that c. of i. is the worst charge that can be laid.

67

Barry 10.07.10 at 10:40 am

“The collapse of the housing bubble would not have sparked the great recession and credit crisis if the bubble had not been over-inflated by the low-quality loans required by government mandate that are now defaulting at unprecedented rates.”

The CRA was passed in the 1970’s, and didn’t cause any trouble then. IIRC, ~1.5% of household loans were made under the CRA, and the repayment rates were as good as other loans.

68

ajay 10.07.10 at 11:04 am

Barry: quite right. The whole “CRA is to blame for the crisis” argument is a lie. (Not an honest mistake; the evidence against it is too good for anyone to make that mistake in good faith. It’s a lie.)

69

Henri Vieuxtemps 10.07.10 at 12:26 pm

@69, I suppose that would make sense if I were an immortal being condemned for eternity to run the rating agency. But as a human being in capitalist society, don’t I have a much stronger incentive to grab a few hundred million dollars I’ve been offered, and let the agency crash and burn – assuming that’s the consequence, which is not obvious at all.

70

politicalfootball 10.07.10 at 12:41 pm

But free markets, while they are far from perfectly rational, do have strong incentives to correctly assess debt risks.

As Henri notes, free markets and ratings agencies don’t seem to work, and there were a bunch of other market failures in the real world, but let’s take a trip to Jim Ross’s universe and look at the free markets there.

To review, in JR’s world:
-CRA-regulated institutions were disproportionately involved in making bad loans.
-GSEs were early instigators to the bad-loan securitization game, rather than late arrivals
-GSE executives were motivated by government mandates, and not the desire to make money.

Even in JR World, that still leaves us with some questions: Why did all of of those “free market” actors imitate the GSEs? How did publicly traded entities like Fannie and Freddie become exempt from free market motivations? And why, if they were exempt, did their behavior mirror the behavior of private actors?

71

politicalfootball 10.07.10 at 12:43 pm

Note that the strikethroughs in the above comment weren’t intentional and might have been the result of the way I hyphenated “bad loan” and “CRA regulated.”

An experiment: What happens if I hyphenate strike-through?

72

roger 10.07.10 at 2:53 pm

The conservative excuse du jour is that the government “mandated” loaning to the poor, hence the crash.The conservative excuse du jour in 2000, when the conservo-pig Gramm was thrusting a deregulated mortage market upon the U.S., was that government regulation imposed burdens on the poor by disallowing the free market from assessing risk and making loans to the poor. Of course, any conservative narrative is wildly fantastic, and constructed solely in the interest of enriching a small number of those morally dubious people who inhabit the upper 1 percentile class. However, the idea that the government caused the crash is a particularly hilarious idea. After all, if the government wanted the poor to have homes, they could, well, like build them for the poor. This was done up until the eighties, when, it was discovered, this was rank socialism. The free market, conservatives assured us then, could serve much better.

It is one disaster after another in the conservative program of always peculating on a wider field. Happily, conservatives have found a country, the U.S., rich for plucking, and evidently intend not to leave until the medium income is a nice 10 thou per year. What’s really sweet about the thirdworldization is getting the peons to actually believe their unbelievable tripe. Although those further up the food chain, your true rightwing media gun doesn’t really believe anything for very long. Belief, after all, is hard to maintain once you have woven your arguments out of short term memory loss.

73

musical mountaineer 10.07.10 at 3:13 pm

How so?

Well, I’m thinking that a bank which issues a loan has a strong incentive to get that loan paid back. It’s where all the real profit in banking really comes from. And mostly they’re quite good at assessing risk, determining qualifications, setting interest, etc. This fundamental process is where government interfered.

So then you had a massive load of bad debts. Now, one could argue that the players downstream, who bundled these bad debts into derivatives and built a speculative market around them, should have figured this out and given bad ratings to those derivatives. But the only way for them to figure it out, would be for them to conduct their own reviews of each loan, or at least review the loan policies to make sure they were sane. That’s a lot to ask! That work was supposed to have been done by loan officers in the first place, and anyway all this stuff was supposedly government-insured. And the people who did the bundling weren’t exactly bankers, they were investors. It’s true, they don’t have incentive to labor through the night in an area where they have little expertise, just so they can down-rate their own instruments.

What you’re basically saying is that government regulation which predictably increased bad debt and created an unsustainable bubble wasn’t the problem. The problem was the lack of regulation downstream. Government should go ahead and force a bunch of garbage into the system, and then force the system to digest that garbage in the least damaging way. That’ll work fine, because government is incorruptible, all-knowing, efficient and wise.

Previously I challenged anyone to explain how derivatives would have crashed the economy if the underlying debt was good. I’m also curious to know how regulation of derivatives could have prevented the damage which would result from holding bad debt in the first place.

74

roger 10.07.10 at 3:36 pm

Musical M.
This is a grand slam of ignorance. Ignorance of the private rating agencies; ignorance of the deregulation of the mortgage markets and how it was supposed to work; and finally, ignorance of the government insurance. You have obviously not read a book or article about how the mortgage market worked – or derivatives, for that matter.

But you can improve yourself. For instance, read Our Lot to find out how the deregulated mortgage business worked (an on the ground perspective). Read Michael Lewis’ The Big Short for a good journalistic account of making money in the “free market” of financial services. Gain some small knowledge of the chronology of the housing bubble, and how Fannie and Freddie lost market share between 2002-2007 because they avoided the subprime market. Then go over the rightwing prop machine’s own comments about the housing bubble when it was going strong under Bush, and find that, at the time, it was attributed to getting the gov. out of the housing business and was a triumph of the private sector. Of course, that part of the story is simply conveniently erased – why, though, you might ask, did conservative tv personalities in such venues as Forbes and CNBC consistently tout the housing bubble? Were they all just poor little sheep?
Really, don’t try to pull this intellectual vapid act. It is bad for who your are. Just proudly stand up for ripping people off, as long as you can get away with it. Which seems to be your true ideological compass.

75

Uncle Kvetch 10.07.10 at 4:09 pm

Some people can (ahem) never admit that noble progressive intentions may contribute mightily to bad outcomes.

Name them.

76

burritoboy 10.07.10 at 4:14 pm

I don’t think the “paid off” explanation does enough work to explain the central paradox: that Larry Summers’ own academic work argues ( at least, in broad terms) against his own economic policy-making. If Summers had always been motivated by profiteering, he wouldn’t have published his academic work – particularly since his academic work undermined the work of the then-leaders of his discipline. And the Chicago School is not known for being particularly gentle to those who criticize it. If Summers had always been about profiteering or personal power, he would have published the same stuff everybody else was doing in the late 1980s and undoubtedly still have gotten an endowed chair, and so on, with almost no risk at all.

It was not at all predictable in the late 1980s that any challenges to EMH would succeed or even be tolerated. While Shleifer and DeLong might have had less to lose, Summers had a lot to lose – if he failed to make a very strong case and failed to persuade a large number of economists, the prominent academic career that was already his could have easily been derailed. (Summers already had tenure at Harvard, while DeLong had only begun teaching in 1988 and Shleifer had taught for a year at Princeton and then a year at Chicago).

77

politicalfootball 10.07.10 at 4:16 pm

Well, I’m thinking that a bank which issues a loan has a strong incentive to get that loan paid back. It’s where all the real profit in banking really comes from. And mostly they’re quite good at assessing risk, determining qualifications, setting interest, etc. This fundamental process is where government interfered.

Hope nobody minds, but I’d like to explore this. It’s really interesting to me how some folks start with the assumption that free markets always work, and then bend their narrative around that view.

M. Mountaineer: Where do you see the government has having interfered with the assessment of risk, determining qualifications, setting interest and whatnot? What behavior did the government engage in that private actors weren’t also doing on a massive scale?

You absolve the “players downstream” from blame because they couldn’t be expected to perform appropriately, but these were all free market actors in a free market system. The government didn’t force the bundling of debt; didn’t build a speculative market around that debt; didn’t force anyone to transact in derivatives that even you acknowledge they were ignorant of. How can you describe the reasons for these transactions in terms of anything other than a market failure? Is “market failure” a concept you can grasp at all? Can such a thing happen in your universe?

But the only way for them to figure it out, would be for them to conduct their own reviews of each loan, or at least review the loan policies to make sure they were sane. That’s a lot to ask!

These were very liquid, largely friction-free markets – more or less a free market ideologue’s ideal. And in actual free markets like these, buyers can choose not to transact – not transacting is the easiest thing in the world. I do it all the time, and pretty much everyone abstained from markets like this in, say, the 1970s. There’s no law that says you have to buy the Brooklyn Bridge, even though in that case I can agree with you that the bridge was build by the government.

Roger rightly takes you to task for not understanding how regulation works, but the really striking thing to me about free-market dogmatists is that they have no internally consistent narrative for how markets work.

78

Tim Wilkinson 10.07.10 at 4:44 pm

jch @61 – most of that sounds about right; I’d take issue with a couple of things

I have a bit of trouble with the notion that any explanation can avoid some sort of “why” question motivating the explanatory endeavor Well, explanation at one level is a logical relation like (though much more complex than) implication, say. There need be no explanatory endeavour (at least relative to a given explanandum) for an account that provides an explanation (of that explanandum) to be arrived at. Even an explanation which is apprehended as such can emerge without being sought – you discover x and only then say ‘ah, that explains y’. Discovering x need not have been motivated by a need to explain y, nor need it be inferred from y’s occurring, nor depend for its warrant on the fact that it explains y. This is obvious stated in such abtract terms, but in this area, the normal rules of obviousness seem to be suspended.

This is important I think, because imputing a particular explanatory aim is often used to discredit or deflect a perfectly good account of events, as for example Summers’s activities are an attempt to find a scapegoat for the banking collapse, a failed atempt to explain it, so, mumble, they fail, so forget about them. The explanation-as-process model also ushers in irrelevant objections – e.g. Occam’s supposed razor, or the old Marxian saw that there is no need to appeal to any explanation via conspiracy… to which the retort is that there is no need for such a need.

Re: ‘quasi-conspiratorial’ events, i.e. (something like, off the top of my head) those whereby a many actions taken together further some shared goal (generally to the detriment of others). There is no general form that such ‘functional’ processes must take, and typically there is a whole range of intentional and non-intentional mechanisms at work at various levels of analysis and applying to various participants.

The attempt to fit all such events exclusively and exhaustively into a smoky-room conspiracy model, or into an invisible-hand model, or into a macrohistorical model is ridiculous IMO. (Further and btw, it is the 2nd and third of these that are, if any are, special modes of explanation, while the first is just a case of intentional explanation of the ordinary everyday kind that Marx uses, e.g. in The German Ideology IIRC, and which even the most simplistic micro-economic model adverts to by invoking rational action.)

Also, para 3; a basically paranoid obsession with hidden motives, though in particular cases such motives might be operative, adds nothing to the general case, and is neither sufficient nor necessary for the identification and explanation of a “conspiratorial” effect this is largely right I think at the level of ontology, but (a) I don’t agree with ‘paranoid’; (b) it does not have firm implications for epistemics or forensics, and {c) is more generally a matter of degree.

a: I don’t think a concern with hidden motive is necessarily paranoid in any useful sense of the term, and the focus on this kind of issue is itself generally beside the point;

b: there’s nothing wrong with inferring an account of events, even an explanatory account in the fullest sense, on the basis of motive., and even with relying on the fact of motive for at least some of the justification for believing the resulting account. Motive alone is highly unlikely to provide a compelling case, but cases have to be taken on their merits. In other words I suppose motive may in some marginal cases provide a necessary part of the evidence that tips an account into credibility, and it may also provide a valuable heuristic in finding suspects for investigation;

c: I don’t in nay case think there’s a clear distinction between operative motive and intention, and the latter will often have an ineliminable role in the acount of events, in particular as providing the teleological mechanism in a functional explanation.

Basically I think far too much oversimplified and over-categorical abstraction has been brought to bear on the issue of ‘conspiracy theories’ and quasi-conspiracy, largely because such can provide an easy way to dismiss a whole class of very ordinary, everyday historical hypotheses without having to consider them in any detail. (Note the functional ‘because’ – the underlying mechanisms are many and various.)

(re Beauregard @63 I’ve just looked at this in a less earnestly abstract light, and I think the reason I couldn’t quite work out what he was getting at is because I was implicitly relying a too heavily on the principle of charity in interpretation, and failed to notice the none-too-subtle implications of his remarks.

That sort of depends on which side of grisly history one stands on and stringing up Summersschwein and his cronies from streetpoles don’t appear to be capable of being taken as anything other than genuine examples of violently antisemitic sentiment. If that’s right, he is cordially invited to do one.)

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Henri Vieuxtemps 10.07.10 at 4:54 pm

When you manage to sell some shit for gold (using derivatives and what-not), the fairy of the markets loves it. And when you sell tons of shit for gold, she gets positively ecstatic. But alas, eventually things collapse, and then she complains that she was drugged and violated.

80

bianca steele 10.07.10 at 4:58 pm

I’ve wondered about the people who say they knew about the bubble and virtuously sold their houses and rented instead: did they take the first offer they got, or having decided to sell anyway, did they hold out and play desperate potential buyers off against each other to get the price bid up as high as possible?

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musical mountaineer 10.07.10 at 6:17 pm

This is a grand slam of ignorance.

I don’t mind that you noticed. My point does not depend on any knowledge whatsoever of derivatives markets, beyond the most basic concept of what a derivative is.

some folks start with the assumption that free markets always work

I explicitly disavowed that assumption, more than once. You guys are the “always” and “never” crowd, not me. Quit projecting. My “defense” of derivative traders is limited to saying that you can’t reasonably expect them to be as angels. Go ahead and say that they’re a bunch of short-sighted delusional criminal bastards who can’t be trusted with a butter knife. Fine, whatever. That thought does not create in me the least bit of cognitive dissonance. It’s more or less what I expect, and it doesn’t bear on my point.

Which is: the federal government, in the service of a noble progressive vision, issued masses of sub-prime loans through Fannie and Freddie, and strong-armed other banks into issuing similar loans. The resulting bad debt, unimaginable in scale, was and is a bad thing. It meant, among other things, that any derivatives based on that debt were bad. How could it be otherwise, no matter how derivatives were regulated or not? Even if derivatives were illegal altogether, the bad debt would be just as big and just as bad.

Name them.

You. All of you. None of you can deal with the historical fact that the government took a dumptruck-sized crap into the finance market. That this great heap of unserviceable debt may have had something to do with the meltdown, you literally cannot imagine. All you care about, all you’re capable of thinking about, is that a few sharp players in the private sector managed to make a buck before the toilets backed up. Scumbags, I suppose, but all they really did was charge exorbitant fees to ship pre-existing turds around the globe so everyone could share in the inevitable stink.

For all I care, derivatives should have been illegal the whole time. I see no benefit to having a free market in arbitrarily-valued, actually worthless paper. The banks carrying the original debt would have all crashed anyway, of course, and crashed much harder because they wouldn’t have exported any of their “troubled assets”. Whom would you have blamed, I wonder?

/daily comment per thread quota

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LFC 10.07.10 at 6:18 pm

beauregard @82: Yet….did Summers and crew have some inkling via their boss Clinton, etc [etc?] of the Bush political schedule, like…the invasion of Iraq??

9/11 created, in large part, the context which made the invasion of Iraq possible. 9/11 occurred, of course, after Bush took office and Clinton had left. Moreover, Bush would have had no reason to pick up the phone during the 2000 campaign, call Clinton, and say: “Hey, if I beat Gore and become president, I’m going to invade Iraq” (on the [somewhat unlikely but not impossible] assumption that Bush already knew he was going to do so). For these reasons among others, the answer to the question above is almost certainly: no.

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Salient 10.07.10 at 6:26 pm

the federal government, in the service of a noble progressive vision, issued masses of sub-prime loans through Fannie and Freddie

Fannie and Freddie do not issue loans to people. They buy loans from other entities, who issued the loans. This is a very basic point of fact. It’s also tremendously important in this context. When you said what I have quoted above, you were stating something that is not true, and that error cascades down through the rest of what you say.

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Salient 10.07.10 at 6:29 pm

Even if derivatives were illegal altogether, the bad debt would be just as big and just as bad.

The hope: those [private] entities might have made better loan choices if they were unable to launder their loans through the derivatives process. Derivatives allowed these bad loans to be laundered.

By analogy: Murder is bad regardless of whether it gets covered up. But. If it were possible via regulation or legislation to prevent a common way of covering up murders, that would be worth looking into, and might plausibly reduce the murder rate. It would, at least, be an option worth considering.

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john c. halasz 10.07.10 at 6:40 pm

#85:

Dean Baker, who was among the very first professional economists to declare the housing bubble, bought a condo upon taking a job with EPI in the mid-90’s for $150,000 and sold it into the bubble for $450,000. Afterwards the D.C. housing price level rose a further 40%. Oh, well! But, yes, for those in a position to do so, ( especially if having bought during the prior trough), recognizing the bubble meant that there was free money lying on the table, probably the only well-earned profit in the whole debacle. What’s puzzling, to the contrary, is the mentality of people who participated in the bubble without recognizing the obvious signs. Or at least, looking on, I found such a (mis)information cascade hard to decipher. It would seem to both cut against the standard account of the rationality of economic agents in terms of utility preference functions, and to underwrite vague imputations of an open-air “conspiracy”.

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Uncle Kvetch 10.07.10 at 6:59 pm

You guys are the “always” and “never” crowd, not me.

[…]

You. All of you. None of you can deal with the historical fact that the government took a dumptruck-sized crap into the finance market. That this great heap of unserviceable debt may have had something to do with the meltdown, you literally cannot imagine. All you care about, all you’re capable of thinking about, is that a few sharp players in the private sector managed to make a buck before the toilets backed up.

Please, do go on.

/daily comment per thread quota

Oh, dear. How unfortunate.

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politicalfootball 10.07.10 at 7:28 pm

Which is: the federal government, in the service of a noble progressive vision, issued masses of sub-prime loans through Fannie and Freddie, and strong-armed other banks into issuing similar loans.

Thanks, M. Mountaineer. I was curious about your foundational delusion, and you’ve identified it for me. No wonder you think lenders can’t be blamed for their lending practices. Salient points out the facts regarding Fannie and Freddie. I’ll add that no law or regulation required, induced or rewarded the making of bad loans.

My “defense” of derivative traders is limited to saying that you can’t reasonably expect them to be as angels.

But I don’t care if they’re angels – that’s why I said nothing about their morality. Nor did I say anything about their intelligence or their other personal attributes. Every word I wrote was aimed at discussing the system in which they worked.

But thanks again. As I said above, I was wondering how your mind would process the words “market failure.” Now I see.

I asked a bunch of other questions above, but I think you did right by not answering. In your universe, where bad loans were either made by Fannie and Freddie or were mandated by law, questions like: “Why did banks choose to make bad loans?” are meaningless.

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politicalfootball 10.07.10 at 7:31 pm

The hope: those [private] entities might have made better loan choices if they were unable to launder their loans through the derivatives process. Derivatives allowed these bad loans to be laundered.

But that wasn’t the only role of derivatives. They not only helped the bad guys cover their tracks, they paid the bad guys.

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bianca steele 10.07.10 at 9:43 pm

@90
Puzzling? The narrative of individual buyers who bought into what everyone with sense knew was a bubble, and the personal failings that caused them to take out mortgages they ultimately couldn’t pay, was all the press discussed for months. If Baker or anybody else wrote about a different narrative, I didn’t notice it (granted, I was not making a close study of that). You still have people like Megan McArdle advising people it’s irresponsible to take out a mortgage, basically (advice nobody was giving out ten or twenty years ago, you can bet on that).

Not that there wasn’t stupidity. Would you take out a $0 down payment mortgage on a $1mil condo in downtown Boston? Would you approve that mortgage?

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burritoboy 10.07.10 at 10:13 pm

our mighty mountaineer friend does not seem to realize that he’s merely casting the government in the role of one of Summers’ noise traders.

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belle le triste 10.07.10 at 10:17 pm

Not really sure why this has not yet been spotted by others — distracted busyness is the charitable answer (you can’t be alert in ten places at once) or mere tin ear (there’s a lot of it about) — but Beauregard is known elsewhere on the net as the “Troll of Sorrow”

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burritoboy 10.07.10 at 10:48 pm

Tim,

I think one problem with what you’re saying is that you effectively make it impossible to distinguish between actual conspiracies and instances where the policy-makers self-deluded themselves or instances where all the participants self-deluded themselves.

Here’s some things to consider:

1. When Summers was involved in the Clinton Administration deregulation, he was participating in something that was widely considered to be correct economic policy. The vast majority of other prominent economists of the time would likely have not done anything differently, and it’s hard to say if any economist who was heterodox enough to oppose this at that time could have even been successfully appointed.
2. The reality is that Summers was probably the most heterodox of the prominent economists of that moment, or at least one of the most heterodox of that time.
3. Not only were the policies under discussion strongly supported by elite opinion, popular opinion was also supportive of it. Remember, we are writing about a population that today is more convinced about free market economics than the economics academe is.
4. We should remember that earlier forms of Chicago School economics have been dominant in Anglosphere countries since the early nineteenth century (with some periods of exception). That does not seem to have been some sort of conspiracy – what conspiracy could last two hundred years all over the world? It’s simply far more likely that people have indeed been truly convinced by this sort of economic thought.
5. It’s really dubious to say that economists have really been bribed into certain modes of thinking. The top level of economists certainly does get a level of cash flow from the business community. But lower levels of economics academe also believe the exact same things while receiving little or no cash flow. And heterodox economists who have become prominent receive cash flow from the business community even if they oppose (some of) the business community’s policies (Krugman being on the board of Enron, Tyson being on the board of Morgan Stanley, etc). There’s a level of cash flow almost everybody with a certain prominence level in economics can get without much additional work, or without even seeking out that cash flow.

There are economic conspiracies, of course. But I think a good analogy would be a nineteenth century Frenchman saying that both the Dreyfus affair and the defeat of the French armed forces in the Franco-Prussian War were both similar sorts of things. One was a explicit conspiracy (which we can document) and the other was something else. They were linked but of entirely different natures.

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john c. halasz 10.07.10 at 11:41 pm

@95:

What time frame are you referring to? I’m talking 2002-2003, when there was mostly just cheer-leading in the press and official denial about any emergent housing bubble. And, yes, I did find the mass behavior puzzling at the time, though I think that is a phenomena that is experienced in every financial bubble, (since it wasn’t just a housing bubble, but a far more extensive general credit bubble).

@98:
Joseph Stiglitz.

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politicalfootball 10.08.10 at 12:44 am

Krugman being on the board of Enron

Krugman was a consultant; not on the board. It seems reasonable to suppose that the small amount of cash they threw his way was an effort to get him to sign on with their program – which I think could have happened in an alternate universe. Krugman is a former Reagan administration official, and was never much of a firebrand liberal until Bush II. Ideologically, he fit right in with Clinton, Summers, Bernanke, et al.

Heck, if Krugman had decided to play ball, maybe he could have gotten a spot on Enron’s board.

Krugman meditates usefully on the subject of conspiracy theories here and here and elsewhere.

95

bianca steele 10.08.10 at 1:06 am

I checked a few per-town house-price histories (going back 10 years) for suburbs in the northeastern US, and almost all of them show a steep slope ending around 2005 (followed by a similarly sharp decline), beginning sometime before 2001, but housing prices around here have always been high. I don’t remember how the various parts of the story lined up against one another chronologically.

96

musical mountaineer 10.09.10 at 11:02 pm

no law or regulation required, induced or rewarded the making of bad loans.

Not directly. They merely mandated making quotas* of loans in certain markets, where the quota far exceeded the number of qualified buyers.

those [private] entities might have made better loan choices if they were unable to launder their loans through the derivatives process. Derivatives allowed these bad loans to be laundered.

Actually, you may have a better point than you realized. Sales of derivatives provided the capital to make many of those bad loans in the first place. So, yeah, if derivatives had been illegal as I suggested, it almost certainly would have reduced the scale of the problem (contrary to my earlier comment).

It also would have meant that banks had far less capital to loan to low-income, no-credit buyers. They would have had to scale back their business with qualified buyers, or what is more likely, disregard their government mandates in the service of a more equitable housing market. And Some People would have screamed bloody murder at those greedy criminal bankers as a result.

Someone is really on about “market failure”, as though I can’t comprehend the concept. I get it, dude, OK? I understand that even free markets can fail, just because nobody has perfect information. But to say that this derivatives market was free and unregulated, is disingenuous. Its incentives, its “opportunities”, and its ability to assess its own risks, were heavily and negatively influenced by government and by politics. Any explanation which leaves this out, will fail to explain.

* quota expressed as a percentage of total business, or something like that. Fuck, it’s complicated.

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incredulous bastard 10.09.10 at 11:43 pm

Krugman made one speech at enron and that’s it. Fannie and freddie got priced out of the market well before it reached its peak and the rent to purchase price in sought after areas had no logical relation to each other. It was a real estate bubble not a subprime bubble. If d2 hadn’t lost interest in this by now he’d be writing this not me.

98

Tim Wilkinson 10.10.10 at 10:58 am

political football @101 – thx for useful links. I guess the first may have included a preview, which doesn’t show up (perhaps due to geo. location), but I’ll find something on it somewhere. It’s evidently about the Hillary Clinton remark, which was especially interesting, beside its content, for being a very rare example of an explicit ‘conspiracy’ claim made by a very mainstream figure – and a politician to boot.

comment on 2nd, NYT, link here. (I’ve just splurged all over another thread and think I should rein myself in now since the comment got far too long and was of only tenuous topicality. As Chris B runs a tight ship, Bristol-fashion, I’ll follow the example of big business and pre-empt any intevention with a judicous bit of self-regulation.)

99

Jericka 10.10.10 at 4:17 pm

I am still hearing people say that the banks had incentive to make good loans because they made money only if paid back. The problem with this is that if those loans are bundled into securities and sold, they have their money back, and then want to make more loans.
There were only so many prospective homeowners who understood debt well enough to be good credit risks, but, the people bundling the loans and selling them wanted to make more money. Commissions in many mortgage lending businesses were based on deals made, not on the long term projected health of the loan. They weren’t keeping it, only making it. What the buyers of the loans cared about was the profit on the loan, which is why subprime adjustable rate loans were made to people who could have gotten better loans if they had been more sophisticated about credit and insisted on them.

It was a shell game where everyone wanted a cut of the money, but the risk was passed on as invisibly as possible. Once the loans were bundled, the buyers depended upon the diversity of the loans in the bundle and the health of the housing market in general. Everyone was making money and no one wanted to look at how the sausage was being made.

100

politicalfootball 10.10.10 at 9:10 pm

They merely mandated making quotas* of loans in certain markets, where the quota far exceeded the number of qualified buyers.

This is another one of those cross-universe communication problems. In our universe the government didn’t mandate bad loans. Had it happened in this universe, the free market would have responded the way it tends to respond: Loans would have become less available, rather than promiscuously available, as the bankers responded to market incentives. If some form of economic activity is a government-mandated money-loser, in our universe people tend not to do it, rather than doubling down on it. In our universe, to understand the way the meltdown occurred, you have to look at the behavior of markets.

What was the enforcement mechanism in your universe? Were people put in jail if they failed to provide loans to bad risks?

Here in our universe, we had the Community Reinvestment Act, which specifically prohibited predatory lending – and for which the only enforcement mechanism was restrictions on mergers for those who chose (note that word) not to comply. As you’d expect, in our universe, CRA lenders didn’t default at worse rates than anybody else, and all the high-profile catastrophes (Bear Stearns, Lehman, AIG) weren’t making loans under the CRA at all.

In your universe, what were the default rates on these government-mandated loans compared to other loans?

101

burritoboy 10.11.10 at 5:54 pm

Everybody is right that Krugman was a consultant to Enron (and primarily gave one speech) and not on the board. And which should make no impact on our evaluation of Krugman’s thought. I’m just pointing out that economics academics on that level have all sorts of cash flow essentially thrown at them indiscriminately without much regard for the substance of their economic thinking.

102

Tim Wilkinson 10.11.10 at 6:22 pm

political football @107 Yes, surely that must have put a stake through the heart of what even in its first brief life was a forlorn and desultory attempt at somehow managing to blame teh Socialists for the latest market fuck-up.

Burritoboy @108: economics academics on that level have all sorts of cash flow essentially thrown at them indiscriminately without much regard for the substance of their economic thinking

I’m not particularly trying to argue a case against Summers (or you) here, but this statement prompted some general questions:

What do you mean by ‘that level’ – is it, for example, the level of getting to be a bigshot of some sort, or the level of being a genuinely accomplished academic economist, or what?

Are there any filter or other mechanisms determining who gets to that level (however it is defined) and if so, might those have anything to do with the expectation of getting money ‘indiscriminately’ thrown at one?

Would an economist whose opinions about political economy fell outside the attenuated spectrum of US mainstream thought also be showered with unconditional largesse (should ‘that level’ be defined in such a way as to include any such economists)?

Might the throwing of money be in the nature of a test to see who will bite?

Woudl it be too much to ask these academics to refuse these gifts on the old-fashioned grounds that they would be beholden even if they tried to tell themselves they weren’t, or because they don’t think its proper to allow conflict of interest, also regardless of their confidence in their own ability to resist bias?

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burritoboy 10.11.10 at 7:29 pm

Tim,

You’ve gotten to the heart of the question.

The question is really how the boundaries of acceptable opinion within anything are determined. In discussing this specific discipline, the specific question we’re trying to answer is:

How are the boundaries of acceptable discourse within economics academia being constructed?

The boundaries of discourse are always going to be somewhat influenced by forces external to the academic field – current political scientists don’t spend much time thinking about monarchy now, partially for the solid reason that there simply aren’t as many monarchies now as there used to be, even if political scientists feel that monarchy should be more prevalent for some reason (which they don’t, but if they did, they’d still be giving mostly courses about democracies). On the other end of the spectrum there could be very clear power/bribery issues – economic academia within the former Soviet Union had a limited discourse available to it for obvious reasons.

So how do we approach understanding this issue in the case of economic discourse? I can’t say I know. We don’t have a situation where modern US economists operate in an atmosphere where political tyranny closely and continually determines economic discourse. On the other hand, we certainly have experienced periods of time within American economics academia when external pressure was strong and explicit (the McCarthy era) or long periods of time where there was some level of implicit external pressure from a variety of forces.

How much has US economics bent to that implicit pressure?

Unfortunately, it’s unclear. But this is likely an unclear question by it’s very nature. For an analog, how much did Anglosphere philosophy develop in relation to the political, social and economic pressures of the day? There were hardly major corporations putting philosophers on their boards. Yet there’s been reasonably plausible narratives suggested where, for example, the long twentieth-century political conflict between the Anglosphere nations and German speaking ones did strongly affect the course of Anglosphere philosophy in the twentieth century. Yet, it’s also plausible to suggest that this political conflict had little or no concrete impact of any sort on the thinking of the major figures of Anglo-American philosophy (i.e., it’s quite possible that Whitehead might have thought the same things no matter what the politics of his time were).

I frankly don’t know how we can examine the question in a more precise way.

We’d need to think about the following:
How narrow are the boundaries of US economics discourse?
How do schools of economic thought operate?
How are status signals distributed in the field?
and so on.

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musical mountaineer 10.11.10 at 7:44 pm

In our universe the government didn’t mandate bad loans.

Thanks for being so gracious. I must confess I’ve been confused by the term “mandate” which seems to crop up in these discussions again and again. It doesn’t seem to be associated with any particular argumentative agenda, either. People on both sides use it, but I’m damned if I can figure out exactly what they’re talking about. Obviously it means something. There clearly was some kind of political pressure on banks to make crappy loans. I don’t think the most committed progressive can argue that bankers decided on their own: “hey, you know what? Let’s loan scads of money to people selected for their lack of creditworthiness. Sure, we’ll lose money on the average transaction, but think of the numbers! It’s a HUGE market!”

That said, I think you can definitely explain much of the damage in terms of market behaviors. Markets really can be fucking stupid, especially when they’re as complex as this one has been. Of course I have a strong bias towards free markets, and I find some of the talk of “market failure” sinister. I think there are obvious advantages to voluntary commerce conducted without force or fraud, and progressive thought generally seems to want to force commerce in one way or another, which sacrifices these advantages. I have little confidence in regulation to make a bad situation better. If there’s anything stupider than a stupid market, it’s stupid policymakers.

I think I’ll read this book before I comment on this subject again.

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Henri Vieuxtemps 10.11.10 at 8:17 pm

I find some of the talk of “market failure” sinister

I agree that the term “market failure” doesn’t capture the essence. It wasn’t a failure, it was a success. People with ingenuity had made huge amounts of money, and that what the “free market” is all about.

Ingenuity can be applied in many different areas: building bridges or selling weapons; treating the ill or selling fake cures to desperate people. Packaging and selling shit mortgages is one of these things.

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burritoboy 10.11.10 at 8:42 pm

“I don’t think the most committed progressive can argue that bankers decided on their own: “hey, you know what? Let’s loan scads of money to people selected for their lack of creditworthiness. Sure, we’ll lose money on the average transaction, but think of the numbers! It’s a HUGE market!””

We’re at this point in the discussion and he still doesn’t understand that the originating lenders sold the loans? Why are you still talking to him?

If he means the eventual owners of the CDO’s – no, they certainly weren’t forced to buy them. Indeed, US CDO’s were particularly well-liked in Europe, for instance. I hope he’s not arguing that the US government forced Europeans to buy CDO’s, is he? There was a very strong, entirely private, market for the instruments of which a very substantial portion was entirely outside of influence by the US government (some simply foreign and some in offshore vehicles).

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musical mountaineer 10.11.10 at 10:05 pm

he still doesn’t understand that the originating lenders sold the loans?

Of course I understand that, and have all along. What I can’t claim to fully understand (and what you may be at pains to avoid understanding yourself), is why. Surely the profit motive is no incentive to throw money away. Nor would incompetence reasonably explain it. Up until somewhere in the late 90s, banks had stringent requirements for issuing credit, that made for a profitable (in the true sense) market in finance. Then their requirements changed. I always thought that these changes were somehow explicitly legally mandated, which isn’t quite true. But it’s close; heavy political pressure had a lot to do with it, and the banks adopted formal policies requiring quantifiable results. Somehow the banks got on board with a progressive project to bring the joys of home ownership to minorities, low-income people, and bad neighborhoods. Somehow they ended up really scraping the bottom of the barrel to find loan buyers, qualifying those buyers on the flimsiest of pretexts in order to meet their “mandate”.

Maybe those bankers were just a bunch of pie-in-the-sky idealists. You can’t argue that they did what they did out of pure unmitigated greed, that’s for sure.

I agree that the term “market failure” doesn’t capture the essence. It wasn’t a failure, it was a success. People with ingenuity had made huge amounts of money, and that what the “free market” is all about.

Wrong. You should say, people with ingenuity had GOT huge amounts of money. They didn’t make a damn thing. It’s a failure.

What a free market is all about, is people bringing the products of their talent, effort, and resources, and trading these for the products of others’ talent, effort and resources. All parties to the market participate voluntarily, because all are enriched by the trade. The material sum of each transaction is zero, but real wealth increases because each party gets what he wants more in exchange for what he wants less. Markets provide natural incentives to create wealth, not merely obtain it. Cripes, I feel like I’m being really condescending. Surely everyone has heard of these concepts?

When you force participation (health insurance mandates) or non-participation (the drug war), or fix prices, you get distorted, fucked-up markets. The end result is either massive waste or needless scarcity. Sometimes it’s helpful to have some government oversight to standardize products and ensure product safety or stuff like that. But the overwhelming majority of political interference in markets ends up reducing wealth and making people less happy. So, force is bad. The other bad thing for a market is fraud. In some way, these derivatives traders defrauded their clients. Perhaps they were themselves defrauded too; they may not have been aware of just how worthless was the paper they were selling.

Really, you think “free market” is nothing but code for “lie, cheat and steal”? You don’t see any possible advantage to individuals doing as they please with their own lives and property?

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burritoboy 10.11.10 at 10:58 pm

“Of course I understand that, and have all along. What I can’t claim to fully understand (and what you may be at pains to avoid understanding yourself), is why. Surely the profit motive is no incentive to throw money away. Nor would incompetence reasonably explain it. “

No, you don’t seem to understand it at all. The originating lender would not care about the quality of the loan because they would be selling it in a very short period of time (usually a period of a few months). Within this period of time, the borrower would only rarely fail to make payments (and sometimes not even need to make any payments at all). The originating lender would sell the loan, collect fees for servicing it and a small profit for originating the loan. After that point, they would be entirely unconcerned what the performance of the loan was.

Your actual question is why investors bought the resulting CDO. This set of people is not the originating lender. In fact, the investors were frequently not US onshore entities at all. The set of investors misunderstood what they were purchasing. The reasons for this are varied: they made assumptions that turned out not to be correct, didn’t understand the risks, did modeling which didn’t encompass the entire spectrum of possible events, etc. None of these reasons are related to US government regulation. Again, the US government doesn’t regulate how anyone does investment analysis, many of the investors weren’t even US domiciled and the US government does not decide what investments investors should be making. There was literally no US government involvement at all on the investor side.

The only reason why the originating bank was making the loan and was unconcerned about loan quality was that there was a very high demand for CDOs. Thus, an originator could unload any quality of loan whatsoever quickly (there were investors specifically looking for very bad credit quality, for instance). If there hadn’t been that level of investor demand, the originators would not have found it so easy to sell loans of poor quality.

None of this story has much to do with government regulation. It literally does not matter if the government forced the originators to make bad loans (which it didn’t). If there hadn’t been investor demand, the originators would have largely kept the loans on their own balance sheets (assuming they had been forced to make the loans) and then blew up in an entirely different way than what we saw.

Your narrative is not only wrong, but worse, it’s irrelevant.

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politicalfootball 10.11.10 at 11:50 pm

I always thought that these changes were somehow explicitly legally mandated, which isn’t quite true. But it’s close; heavy political pressure had a lot to do with it, and the banks adopted formal policies requiring quantifiable results.

I can see you struggling to understand this, but this just isn’t true. Lenders made bad loans because it was profitable for them to do so, just as burritoboy explains. The whole point of the term “market failure” is to describe a situation in which rational market actors seeking their own best interests induce a catastrophe. Until you understand how that happened, you’re not going to make any progress on this at all.

And again, even in your universe, your explanation makes no sense – that’s why you’re forced to describe the actual events you posit as having taken place “somehow.” You aren’t able to identify a mechanism for these events because no such mechanism exists, or could exist. burritoboy is being too charitable to your analysis of your alternate universe by suggesting that the banks would have blown up for different reasons if the government mandated unprofitable loans. In fact, they would have stopped lending.

Libertarians who misunderstand Econ 101 are normally very good at understanding this concept – indeed, it’s pretty much the only thing they do understand. If the government makes behavior economically disadvantageous, that activity ceases, right?

I think you’re wise to look into this further, and while Yves Smith isn’t my favorite financial writer, she’s not an idiot. Any non-idiot author will be able to explain this matter to you. The view you’re reading here isn’t some leftist view – it’s the view of everyone who has looked at the situation. Your narrative on this is similar to the creationist narrative. Creationism isn’t a scientific view, it’s a political view. Government-mandated-meltdown is not the view that any reputable financier or economist holds, it’s what political commentators profess to believe.

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john c. halasz 10.12.10 at 1:05 am

Just to add a belated U.S.-centric note, the housing bubble wasn’t simply a matter of subprime. If you’re going to blow a housing bubble,- (which doesn’t necessarily require the machinery of structured securitization set up by Wall St. here, since ordinary banking folly will do, but that is the main culprit for the size and duration of the bubble in this case)-, then to get people to sell their houses at a profit and move up the ladder to better houses, (with expectations of further appreciation), you need feeder-stock at the bottom of the market to start the price-appreciation chain. Which is the real point about the sudden expansion of the subprime “space”: white home ownership rates were at 70%, whereas black and Hispanic rates were at 45%, so if you’re going to increase the home-ownership rate, as a prerequisite for blowing the bubble, where do you think the extra supply of suckers is to be found? The lenders might have cottoned on to the rhetoric of the “ownership society”, (itself a right-wing, “free market” ideological trope), to disguise their aims, but it hardly amounts to an actual causative factor. Rather blaming subprime borrowers, (often enough victims of predatory practices), amounts to a typical right-wing strategy of blaming the victims to cover the tracks of the powerful and deliberate interests of the right.

I have no respect for advocates of “free markets” who don’t even understand the basic issues of market *structure*.

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musical mountaineer 10.12.10 at 1:18 am

Your actual question is why investors bought the resulting CDO.

Well, no, that’s the part I can understand. As it seems to me, these buyers would be at several removes from the people who approved the underlying loans. Such a buyer might well not know or care under what policies the loans were issued. He would take it on faith that the loans were issued under policies that would mostly ensure payment. After all, that’s what banks always did before. And yup, that’s pretty much exactly what you said.

I take your point that sales of CDOs provided an incentive to banks to originate loans, and insulated them against the inevitable defaults. This, coupled with the excerpt from Wikipedia below, suggests how politics could have played a role:

In 1999, Fannie Mae came under pressure from the Clinton administration to expand mortgage loans to low and moderate income borrowers by increasing the ratios of their loan portfolios in distressed inner city areas designated in the CRA of 1977.[10] Because of the increased ratio requirements, institutions in the primary mortgage market pressed Fannie Mae to ease credit requirements on the mortgages it was willing to purchase, enabling them to make loans to subprime borrowers at interest rates higher than conventional loans. Shareholders also pressured Fannie Mae to maintain its record profits.

Now, I do not care to argue further; I’ve been schooled in this thread and I may as well admit it. My ideas of what went on here, while they were reasonable conjectures based on what information I had, were mostly wrong. I suspect that if and when I learn more about it I’ll know exactly what I should have said. That’s often how it goes.

For now, bye and thanks for your time.

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john c. halasz 10.12.10 at 1:53 am

THE HILLS ARE ALIVE WITH THE SOUND OF MUSIC…!

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jericka 10.12.10 at 2:04 am

The banks were lending to make money, but, they no longer have to buy and hold to to it. They can make the loan, and sell the loan, and once it is out of their hands they don’t have to care whether the loan was a good risk or a bad risk.

In fact, there was such demand for the loans from investors that the banks lowered their standards themselves. The banks and mortgage brokers were the ones who came up with the exploding ARMs and liar loans. The government wasn’t that clever.

Notice I didn’t call the banks smart, though.

The banks made loans with an initial lower payment rate that reset to a higher rate somewhere sometimes years down the road. The assumption made was that the buyer could always refinance(HA!) or that they’d sell the house in a few years and move up before the loan reset.

Unfortunately, when things tanked, refinancing was no longer an option. Moving was no longer an option, and people were lucky if they still had steady full employment.

Should the buyers have been more sophisticated about credit and debt? Sure, but, a loan is a contract with two sides. The banks came up with the terms and qualifications. The banks should have made sure the borrowers could pay, but, the reality is that they really didn’t care. They were offloading the loans anyway, and if they went bad a few years down the road that was someone else’s problem.

Once everything was bundled into a colateralized debt obligation, it was hard to pick through the bundle for any specifics. Usually, there were details like credit scores, but, when the loan itself is structured so that three years in, the monthly payment jumps by $500 or more, that may have more of an effect on whether the family can make that payment or not.

The investers scooping up the bundles weren’t looking too closely at the deals they were making. Real estate was always a safe investment, right? (Ha! again)

It was a shell game where the risk was being passed on to the next buyer down the line, but the profit stayed with the bank or broker making the loan.

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burritoboy 10.12.10 at 2:07 pm

“Such a buyer might well not know or care under what policies the loans were issued. He would take it on faith that the loans were issued under policies that would mostly ensure payment. After all, that’s what banks always did before.”

Again, you don’t understand the problem. The investors in CDOs were nearly entirely institutional – CDOs were generally only sold in very large sizes (usually in pieces of 1-10 million USD each) and generally sold to highly sophisticated institutions who had considerable staffs to analyze these investments. That is, if you are that investor, you’re in a situation where an originator is selling you something out of their own portfolio. Thus, the first question is: why does the originator want to dump this? Now, there can be excellent answers to that and horrible answers to that.

There’s obviously something different about a loan the originating bank is keeping in it’s own portfolio versus one it is selling to external buyers. There’s no reason to assume the two are the same and an investor naturally should view the two as different. It is irrational to simply assume (to take on faith, as you put it) that lending standards are uniform across the two situations.

In fact, banks have sold whole loans for many decades. Buyers of whole loans always assume that the loan being sold has some sort of problem with it. To get buyers interested, the bank will usually open a data-room where potential investors can come in and look at the bank’s entire file on the loan (examine the bank’s records, the bank’s analysis, notes of the bank’s meetings with the borrower, etc). Generally, whole loans will not be sold at face value precisely because the buyers locate the problems and demand a discount.

Investors extended portfolio theory to portfolios of loans. The problem is that the correlations of default were higher than they expected. They did not do the type of work normally done to purchase whole loans because they had overconfidence in their understanding of portfolio theory. The US government does not regulate investment analysis in any way and, indeed, has no opinion whatever on how to do investment analysis.

Thus, it’s irrelevant if the US government pressured banks to make lower quality loans (which they didn’t do anyway). If there hadn’t been strong investor demand for the CDOs, the banks would simply stopped lending and lobbied very hard for rule changes. You would have seen the following transaction: the originating bank would make low-quality loans ->bundle the loans -> only obtain significantly below face value prices for the CDO -> take equity loss and writedown – > not repeat transaction -> lobby government. We would have seen this scenario 5-10 years before 2007 if your narrative was true.

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