The smartest guy in the room?

by John Quiggin on September 24, 2008

One thing that really puzzles me about the great bailout plan is the almost universal acceptance that Paulson should be the one to run it, at least until the next Administration. More generally, I’m surprised by the kid-glove treatment he’s been getting in public discussion, even from people highly critical of the plan.

Let’s stipulate that he’s a smart guy. He wouldn’t have risen to the top in Wall Street if he wasn’t. And, of course, if having smart guys running the show was sufficient to ensure good outcomes, Wall Street wouldn’t be in its current mess.

Looking back at the record, plenty of people have observed that, at least in his public statements, Paulson repeatedly underestimated the severity of the crisis. And there’s nothing in the ad hoc shifts between cash infusions, bailouts and bankruptcies to suggest that he has much more of an understanding of what’s going on than anyone else. As Paul Krugman has said, he’s making it up as he goes along, just like the rest of us.

But the bailout plan is something else. The possibility of a meltdown like this has been talked about, increasingly seriously, for the last couple of years. Yet Paulson responds with a three page document saying “I need $700 billion, no questions asked”. Wasn’t there a contingency plan? Or worse still, was this the contingency plan?

Either way, Paulson should be sacked forthwith.

{ 114 comments }

1

glenn 09.24.08 at 7:27 am

Actually, what’s much more likely is that he’ll stay on for quite some time in the next administration, whoever wins.

2

Ray 09.24.08 at 8:14 am

You’d think the fact that he lied to Congress would get more play too. He told the hearings that he was all in favour of oversight, he just didn’t want to pre-empt Congress by specifying the form this oversight should take. But he submitted a plan that explicitly said there should be no oversight, of any sort, of the way he spent the money.

3

Barry 09.24.08 at 8:18 am

“One thing that really puzzles me about the great bailout plan is the almost universal acceptance that Paulson should be the one to run it, at least until the next Administration. More generally, I’m surprised by the kid-glove treatment he’s been getting in public discussion, even from people highly critical of the plan.”

Shades of ‘the CEO Administration’, and ‘He’ll be surrounded by good people’.

4

Bill Gardner 09.24.08 at 8:23 am

How much Goldman Sachs stock does Paulson still own?

5

almostinfamous 09.24.08 at 8:58 am

i think whoever comes into power would be better of letting Nouriel Roubini take charge of the financial industry.

6

jonst 09.24.08 at 9:53 am

I challenge your premise that because he rose to the top of GS we will stipulate he is smart. Shrewd. Perhaps. Well connected. Perhaps. Smart? Perhaps….but not necessarily so.

7

Steve LaBonne 09.24.08 at 10:29 am

Actually in the left blogosphere he’s been coming in for plenty of well-deserved abuse and calls for his resignation. But indeed, the deference shown to him by mainstream Democrats, including Obama, has been sickening. (Who listens to the left? Sigh.)

8

A. Y. Mous 09.24.08 at 10:40 am

I say haul the J. P. Morgan Chase Stanley & Sons & Brothers & Company execs into the court house. Paulson is not calling the shots. Or at best he is calling it on behalf of someone. Goldman Sacchs is too obvious. I say JPMCSSB&Co. That 700 billion is bailout of the creditors of those bad debts. Not Bear Sterns, not Merril Lynch, not AIG, not Lehman Brothers. They owed money and could not pay. Who did they mortgage their mortages to?

As an aside, I can understand consumption. I can understand credit. I can understand consumption on credit. I can understand consumption of credit. What I can’t understand is, how does one consume credit on credit?

9

almostinfamous 09.24.08 at 11:19 am

What I can’t understand is, how does one consume credit on credit?

you hire some high-falutin PhD’s to invent financial bistromathics calculations to hide the fact that you can’t actuallydo what you’re doing. presto! faster-than-light travel!

10

Lisa 09.24.08 at 11:30 am

I think there is some kind of fear that sacking would mean disorder. In a crisis people tend to want someone to look to. He’s obviously the wrong person for that.

11

ehj2 09.24.08 at 11:32 am

Well, Paulson is certainly shrewd, and heavily invested somewhere. It’s hard to imagine how he’s a disinterested party in this (or any) bailout.

~~~

It is not a stretch to suppose that, at the margin, the chance to unwind his stake in Goldman Sachs tax-free may have had an influence on his decision to take the Treasury job. After all, if he were to completely divest himself without any tax relief, he would be staring at a tax bill of well over $100 million, Willens says.

Paulson need only obtain a “certificate of divestiture” from the Office of Government Ethics to sell off his 3.23 million Goldman shares, worth about $484 million, tax-free.

http://www.forbes.com/2006/06/01/paulson-tax-loophole-cx_jh_0602paultax.html

12

abb1 09.24.08 at 12:08 pm

Well, he is a member of the Bush administration; ’nuff said.

13

Robbie Taylor 09.24.08 at 12:31 pm

There is no need to be smart to rise to the executive position he has. George Bush and Dick Cheney are evidence of that. All it takes is the ability to bully other people into letting you have your way, an ability he is currently demonstrating on the spineless Republocrats in Congress. They’ll show him – instead of $700 billion, they’ll just give him $699,999,999,999!

14

John Emerson 09.24.08 at 12:41 pm

Paulson’s better than Gramm.

15

ehj2 09.24.08 at 12:45 pm

abb1, @12

Of course that should be sufficient to discredit Paulson. These people can’t run a war with a 3rd world country that has no navy, airforce, or army; can’t steward the economy without bankrupting millions and savaging the most prestigious institutions on the planet; or manage the aftermath of predictable storms on the Gulf. They shouldn’t have 1% of the vote, let alone 45%.

Robert Reich has it right — this is about Trust. Trust and Transparency are foundational to everything in the Social Contract, not just to working markets, and the Republicans work purposively to sow distrust of Government (and governance), and corporatists work purposively to design financial instruments and systems that are so opaque that professional economists acknowledge we can’t determine what portfolios are worth.

The self-proclaimed “Masters of the Universe” have “Architected their own Reality,” and no one knows what it is.

This election seems framed to be about “Change” and perhaps it should be about “Trust.” The time of Trusting Republicans with the National Security of any part of our world should be over.

John, @13

And anyone who isn’t actively lying to Congress would be better than Paulson. I don’t care how smart someone is, if they’re lying to me, they’re not on my side.

16

Bill Gardner 09.24.08 at 12:54 pm

Why not apply medical academic COI rules to Treasury Dept. personnel? (Not that those rules are airtight!) Paulson should say, before testifying or giving a press conference, “I own 3.23 million shares of stock in Goldman Sachs, a bank holding company.” (Worth $404m at this mornings $125.05 / share.)

Of course I understand why this won’t happen, but it should.

17

J Thomas 09.24.08 at 1:46 pm

Paulson’s better than Gramm.

Damning with faint praise?

Hey, whatever happened to Greenspan? Should’t we at least get Greenspan in front of Congress to testify under oath about what happened, and why it happened, and what he would do about it if he had the chance to do something?

A lot of people used to trust Greenspan. He ought to get some public spotlight now, explain just what he was doing when he set us up for this.

18

noen 09.24.08 at 2:06 pm

ehj2:
These people can’t run a war with a 3rd world country that has no navy, airforce, or army; can’t steward the economy without bankrupting millions and savaging the most prestigious institutions on the planet; or manage the aftermath of predictable storms on the Gulf.

You are presuming their intent is the same as yours would be. The war in Iraq has been a resounding success from their point of view, they’ve never had any desire to “steward” the economy and the aftermath of Katrina has been highly profitable for the “right kind of people”. It is a mistake to take their public persona at face value.

19

Markup 09.24.08 at 2:10 pm

Of course that should be sufficient to discredit Paulson. These people can’t run a war with a 3rd world country that has no navy, airforce, or army; can’t steward the economy without bankrupting millions and savaging the most prestigious institutions on the planet; or manage the aftermath of predictable storms on the Gulf.

Mission Accomplished. People still assume that somehow altruism is supposed to be involved. Silly people.

20

Harry 09.24.08 at 2:25 pm

Gretchen Morgsenson was brutal about him, and the whole bailout, on Fresh Air last night — I don’t read the Times much, but I assume she is being brutal there. I think there is a general weirdness about the political (and journalistic) culture here. It is not that there is no honour (there isn’t, but that’s not what is weird — I can think of only one British politician who has resigned a post because she judged herself to have made an unacceptable error in the past 20 years), but that there is no clamour for resignation on anything other than partisan grounds. Clearly, Clinton should have resigned over lying to the public and his party about Lewinsky; clearly Bush should have resigned over the absence of weapons of mass destruction (and Rumsfeld and Cheney and…), clearly Paulson should have resigned by.. well, by the time he went for the AIG bailout. But I do not remember Democrats calling for Clinton to go, or Republicans calling for Bush etc to go; and as for Paulson, JQ’s call doesn’t even count because he’s foreign — who else is calling for this?

21

Quentin Crain 09.24.08 at 3:04 pm

Hmm, is this question serious? Looks like more Chomsky, Silber and a host of others needs to be read more: We have one party with two wings.

So when you say:

More generally, I’m surprised by the kid-glove treatment he’s been getting in public discussion, even from people highly critical of the plan.

I do not know what people are “highly critical of the plan” in any meaningful, strategic, non-tactical way?


Sector Total To Dems To Repubs
Agribusiness $7,587,571 $2,945,870 $4,624,051
Communications/Electronics $34,228,994 $25,358,758 $8,793,921
Construction $16,754,615 $7,158,588 $9,572,327
Defense $2,071,922 $1,111,020 $951,802
Energy & Natural Resources $8,955,401 $3,348,737 $5,601,614
Finance, Insurance & Real Estate $114,465,564 $59,847,674 $54,548,348
Health $30,141,119 $18,411,015 $11,679,446
Lawyers & Lobbyists $75,555,649 $56,936,901 $18,583,593
Transportation $6,530,813 $2,261,194 $4,261,821
Misc Business $60,335,832 $35,476,723 $24,754,609
Labor $756,158 $727,063 $28,195
Ideological/Single-Issue $18,220,844 $13,535,021 $4,684,122
Other $117,873,314 $70,654,807 $46,893,782

Sector contributions during this presidential campaign: http://www.opensecrets.org/pres08/sectorall.php?cycle=2008
( What am I missing? ) http://www.opensecrets.org/pres08/sectorall.php?cycle=2008

22

Sebastian 09.24.08 at 3:31 pm

“The possibility of a meltdown like this has been talked about, increasingly seriously, for the last couple of years.”

I don’t like the Paulson bailout plan. I’m pro-capitalist system, and part of how that system functions is by letting people who made horrific choices lose their money. Now I’m not an absolutist, so if the government needs to step in to keep the people who made horrific choices from dragging the whole economy down with them, I’m fine with that. But whenever possible the people who made horrific choices should lose the money they invested in horrific choices. Letting people think they can take huge risks with no chance of loss is bad in the short run and really bad in the long run.

I’m not sure Paulson’s plan comes anywhere near that approach.

But that said, the possibility of a meltdown ‘like this’ really hasn’t been seriously talked about as far as I can tell. AIG? They’ve had trouble around the edges their whole corporate existence but I don’t think the idea that it could fail outright was seriously contemplated by very many people (I only hedge because I’m sure one person somewhere said it was possible). The idea that the money market funds could have serious problems wasn’t anything I’d heard about. I’m all for fair attacks on Paulson. I don’t think he’s done a great job, and I certainly don’t like his bailout blank check. But unless I’m misunderstanding the whole thing, the criticism that he didn’t forsee this isn’t a really good one.

23

abb1 09.24.08 at 3:33 pm

Hey, more “defense” dollars to the Democrats than to the Republicans? How ’bout ’em apples?

24

Nur al-Cubicle 09.24.08 at 3:58 pm

I prepared economic press summaries for a European bank from 2005 to 2007. From what I read, the European Central Bank bigwigs would repeatedly tell Bernanke and Paulson that they had looked at the activities of Wall Street (indeed, many were Goldman Sachs alums) and were extremely concerned about these activities and the herd mentality driving them. They’d say, Gee, maybe you need to at least order transparency on these high-risk transactions and hedges. You know what? The ECB people were sneered at and insulted.

Paulson and Bernanke knew years ago what trouble they were in and did nothing, a la Coolidge.

25

ehj2 09.24.08 at 4:40 pm

Noen, @18,

I think we understand that 1% benefit from these serial crises. My point (@15) is they have closer to 45% of the electorate. If 40% of that 45% woke up, those remaining wouldn’t dare propose serial crises to benefit themselves — they’d be revealed as the “friends of terrorists” (what they call Obama) they are.

The only place to begin is transparency and a more “honest” media, so I’d like to see media restructuring as part of the bailout deal.

Can we have Krugman in charge?

26

a. y. mous 09.24.08 at 4:42 pm

And I quote

“Baying for blood. I did that when the other attacked me and mine. I did that when we played tit-for-tat and routed them. I did that when they did not save me or mine during the Flood . I am baying for blood now, now that I am robbed. I am not poor. I am not of the “courtesan addicted merchant class”. I am neither illiterate nor a seminary exile. I am baying for blood. Justice does not comprise merely of restitution of the victims. Justice also includes punishing the guilty. Blood will be spilt. Sooner or later. I pray sooner. For I bay for blood in my present lifetime.”

27

Sebastian 09.24.08 at 4:47 pm

“They’d say, Gee, maybe you need to at least order transparency on these high-risk transactions and hedges. You know what? The ECB people were sneered at and insulted.

Paulson and Bernanke knew years ago what trouble they were in and did nothing, a la Coolidge.”

See this is where your theory has problems. Thus far at least, the problems haven’t been caused by hedge funds, it has been much more traditional things. And the AIG transactions really weren’t high risk in the conventional sense either.

The basic problem is that buyers, sellers and mortgage lenders all acted as if there was some sort of physical law of increasing house prices.

28

Walt 09.24.08 at 5:06 pm

Sebastian, if you don’t think serious trouble was widely mooted for some time, you haven’t been paying attention. The fact that the banking system was in serious danger has been clear since the Bear Stearns collapse.

29

Michael 09.24.08 at 5:12 pm

“But that said, the possibility of a meltdown ‘like this’ really hasn’t been seriously talked about as far as I can tell. AIG? They’ve had trouble around the edges their whole corporate existence but I don’t think the “idea that it could fail outright was seriously contemplated by very many people (I only hedge because I’m sure one person somewhere said it was possible). The idea that the money market funds could have serious problems wasn’t anything I’d heard about. I’m all for fair attacks on Paulson. I don’t think he’s done a great job, and I certainly don’t like his bailout blank check. But unless I’m misunderstanding the whole thing, the criticism that he didn’t foresee this isn’t a really good one.”

On the contrary, it is an excellent one. First, any number of people have been putting their money behind exactly this idea since last August when the first writedowns hit. Simply look at the short interest and put option action on the investment banks, some of the more insane thrifts, and, yes, AIG. Not only were people predicting it, they were betting huge amounts of money that they were correct. And they would have made even more on their correct investment decision if the government didn’t decide that bailing out the ignorant long-side was what governments were supposed to do.

Second, people who understand that massive leverage on subprime mortgages is a bad idea could simply point to the institutions that had the most such leverage. Books have been published on this by economic analysts and securities analysts.

Third, anyone who spends much time looking at housing policy could see that many of the mortgages being bundled to Wall Street and to investors were simply fabrications: fabulously expensive reverse mortgages sold to 70-year old pensioners. $150K loans on 700 sq ft 1930s era steelworker housing in declining cities. Liar loans in an economy that did not expand employment. Never mind the predatory ARMs. This has been on policymakers radar screens since the late 1990s. For goodness’ sake, Federal Reserve bankers have been publishing books on this stuff since the early 2000s. All of these people could see how securitization disconnected loans from risk. That silly people elected to buy those loans based on some historical modelling of foreclosure rates was simple ignorance. In case you might think this is an obscure policy arena, Gretchen Morgensen has been saying the same thing at the NY Times since last summer.

Fourth, scholars have been writing about the financialization of our economy and the historically high, and unsustainable, ratio of leverage to GDP growth since the late 1990s. Similar analyses have been developed by several blogs and sites that offer financial commentary. In the latter circles, the only question has been whether the inevitable endgame will result in inflation or deflation.

So, to summarize: it was predicted, in numerous venues, over various forms of media, over the course of many years, by people with a variety of intellectual and political orientations and differing degrees of financial interest.

I understand that this is a complex issue. Nonetheless, I am utterly mystified by self-confident assertions that it was “not predicted”. I don’t understand where the need to think it wasn’t predicted comes from. I have heard this said many times despite mountains of evidence to the contrary. If you can shed light on this I would be most interested.

30

Michael 09.24.08 at 5:18 pm

One more thing, Paulson’s former employer, Goldman Sachs, famously predicted it and was on the short side by the time of the Bear Stearns collapse. In fact, there was all kinds of talk about how GS had abandoned its fiduciary responsibility in going short while continuing to sell long. I think Paulson would have heard.

31

green apron monkey 09.24.08 at 5:37 pm

Are you saying that whoever he would be replaced with wouldn’t be making it up as he goes along?

32

roger 09.24.08 at 6:00 pm

I’m not sure what Sebastian’s talking about. The Credit Default swaps were the single reason for rescuing AIG, just as counter-party risk was the single reason for arranging Bear Stearns absorption by Morgan. Far from insuring against first tier risk, the only viable economic reason for a rentseeking thing like a derivative, they have spread risk catastrophically through the entire system.

If, instead of using fictional instruments to bet on real equities, the banks had simply given their brokers money to bet in Las Vegas, they’d be in better positions today.

33

engels 09.24.08 at 6:07 pm

the possibility of a meltdown ‘like this’ really hasn’t been seriously talked about as far as I can tell

Is ‘seriously’ the important word in this sentence?

34

Righteous Bubba 09.24.08 at 6:14 pm

Is ‘seriously’ the important word in this sentence?

Most amusing.

“Serious” question from one with little market knowledge: if the over-leveraging of mortgages is the awful thing, are we not going to have to accept that this magical money should somehow be gone no matter what?

35

Michael 09.24.08 at 6:33 pm

Or you make it not magical. I think this is the reasoning behind some of the Main Street arguments.

36

roger 09.24.08 at 6:39 pm

Mr. Bubba, I think that is one of the central questions. It seems to me that to fill the “hole” to make the credit markets liquid – to go back to the financial system we knew a month ago – will take a seven hundred billion dollar bailout every year for the next century – for that is the order of the losses that we’ll see in the CDO and CDS markets. Far better to allow bankruptcy rules to prevail, reorganize the derivatives market around a central exchange instead of OTC, much as the stock market is arranged, and require every financial institution that wants to play in the shadow system to make its transactions through that institutional exchange. It is obvious that the shadow system has completely failed, thus invalidating the entire neo-classical theory that the private markets, if you just set them free, would be able to provide more efficient insurance for risk than those nasty old regulated instruments, not to speak of the state itself. That, it turns out, was bullshit especially designed for rentseeking billionaires.

37

Sebastian 09.24.08 at 6:46 pm

“Sebastian, if you don’t think serious trouble was widely mooted for some time, you haven’t been paying attention.”

Serious trouble, yes. Serious trouble like this, not really. That is the whole problem with hindsight: you already know what actually caused the trouble so you think that all of the warnings about it were obviously good while you discount all the warning about all the other things.

For example (and it even comes in to this thread where hindsight bias should be protecting some of you from talking about it): hedge funds. This is one of the areas where the alarms were actually being sounded the loudest over the past 3-4 years. All sorts of hand-wringing was made about how the lightly regulated hedge funds were going to destroy us. But in reality, hedge funds have had almost nothing whatsoever to do with the financial disaster area we see. The actual disasters took place in two of the most highly regulated areas–mortgages and insurance.

Example #2: weak dollar. There have been all sorts of pronouncements about all the nasty things a weak dollar is going to do to the US economy vis-a-vis the world economy. For all I know they may be true. But what is definitely true is that the weak dollar played little to no role in this disaster.

I’m well aware that there were all sorts of ‘serious trouble’ which was mooted. And some of it even had to do with how we were going to deal with the housing bubble.

But I defy you to find me say three seriously regarded economists (from anywhere on the left-right axis) or three central bankers or three high level government policy experts or even one each from those areas that were saying (2 years ago, 1 year ago or even as recently as 6 months ago) that a likely fallout from the real estate bubble deflating/ending/collapsing was that AIG might go under or that money market funds might collapse.

Now was some unlistened to analyst saying such things? Perhaps. Though I doubt he was saying all of those things. And in hindsight he looks brilliant. But that is hindsight.

We really need to be humble about the limits of human knowledge and control.

38

Michael 09.24.08 at 6:49 pm

And we need to recognize when academic disciplines become blinded by dogma…

39

abb1 09.24.08 at 7:03 pm

– did the deceased sweat before dying?
– yes, doctor, he did.
– good, good, very good.

40

geo 09.24.08 at 7:24 pm

But I defy you to find me say three seriously regarded economists (from anywhere on the left-right axis) or three central bankers or three high level government policy experts …

Forgive me, Sebastian, but this seems a silly formulation. Isn’t it obvious that any economist or banker or policymaker who insisted on the recklessness and immorality of a financial regime that was making the class of people who largely finance political parties, make large gifts to universities, or employ ex-central bankers obscenely rich would soon find himself no longer highly regarded or high-level? Numerous obscure leftists (and non-leftists) have been predicting a catastrophe of just this sort for many years: eg, Nouriel Roubini, Michael Hudson, Doug Noland, Loren Goldner, Robert Kuttner, etc, etc. Perhaps you will regard them a little more highly now?

41

jack lecou 09.24.08 at 7:32 pm

But I defy you to find me say three seriously regarded economists (from anywhere on the left-right axis) or three central bankers or three high level government policy experts or even one each from those areas that were saying (2 years ago, 1 year ago or even as recently as 6 months ago) that a likely fallout from the real estate bubble deflating/ending/collapsing was that AIG might go under or that money market funds might collapse.

Coincidentally, AIG posted it’s largest loss in 89 years back in March, just over 6 months ago. It was due to… a decline in mortgage backed investments. That’s not even a controversial dire warning from some academic economist, just the business page.

And from a year ago, I can easily find news items mentioning, for example, alarming jumps in the delinquency rate of AIG’s mortgage portfolio.

From two years ago, the top result is an article in “American Banker” which says,

Mortgage insurers are concerned that regulators are not moving with enough speed to put the brakes on nontraditional home loans, particularly option adjustable-rate loans taken out with “piggyback” home equity ones as down payments.

“Recent trends show alarming signs of ongoing undue risk-taking that puts both lenders and consumers at risk,” Suzanne Hutchinson, the trade group’s executive vice president, warned regulators in a July 10 letter. The insurers are “deeply concerned about the potential contagion effect of poorly underwritten or unsuitable mortgages,” she wrote.

That’s not hindsight. This crisis has been very clearly in the making for years, anyone who was paying attention could connect the dots.

42

engels 09.24.08 at 7:40 pm

We really need to be humble about the limits of human knowledge and control.

Slam that stable door shut!

43

jack lecou 09.24.08 at 7:45 pm

I would also say that to the extent that there is a lack of dire or specific warnings from central bankers and the like is because no one, inside or out, really had a clear idea of the extent of the whole tangled mess. Not until it actually started unraveling.

That’s why the sorts of things you heard from responsible people like Al-Cubicle’s central bankers are not proclamations of doom, just mild-mannered calls for greater transparency. Calls which were… ignored.

44

almostinfamous 09.24.08 at 7:58 pm

Now was some unlistened to analyst saying such things? Perhaps. Though I doubt he was saying all of those things. And in hindsight he looks brilliant. But that is hindsight.

geo mentioned Roubini. here’s what the NYT had to say about him, rather snarkily, around the time of the Bear Stearns debacle:

On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.

45

engels 09.24.08 at 8:06 pm

I think Sebastian is just making the standard right-wing argument I think we have all heard by now in many other contexts. I was driving my car at night, on the wrong side of the road, with no headlights, while high on crack cocaine. I crashed into a car driven by Mr Smith, who was driving his family back from an evening out at the cinema, killing all of them. My defence? I had no idea this would happen. Who could possibly have known that the Smiths would have gone to the cinema that evening?

46

Michael 09.24.08 at 8:10 pm

You are unjust to the right-wing…

47

Sebastian 09.24.08 at 8:24 pm

Yes we’re all going to die because of global warming.

[asteroid hits]

See I said we were all going to die.

48

Watson Aname 09.24.08 at 8:26 pm

So Sebastian, which part of the quote in 44 do you think was talking about `global warming’ ?

49

Michael 09.24.08 at 8:39 pm

It is comical that Sebastian is passing judgement on the quality of analyses that he did not know existed until a few minutes ago. Unfortunately, he is indicative of how we got in this mess. The willfully ignorant have been running the show. That is why, in my opinion, people insist this couldn’t have been predicted. To acknowledge that it could have been requires one to confront the dogmatic and/or uninformed nature of one’s own thinking. The smart and pragmatic ones, say Greenspan, instead implausibly insist that they too predicted it, they were just constrained by events.

50

jack lecou 09.24.08 at 8:59 pm

Yes we’re all going to die because of global warming. [asteroid hits] See I said we were all going to die.

Please help me out if I’m reading you unfairly, but this just seems pathetic.

Basically, you seem to be acknowledging that a people were warning that the unraveling of the MBS market was going to wreak havoc with hedge funds, etc. (Also, asking for more transparency in the market so we could sort out the problems and fix them early…)

But then you’re saying “But those doomsayers were WRONG, the unraveling of the MBS markets ended up wreaking havoc with money market funds and insurance companies. Who predicted that? We really need to be humble about the limits of human knowledge and control!”

Which I guess is true. Especially when the markets in question were explicitly set up to be opaque and out of control…

51

ehj2 09.24.08 at 9:03 pm

Michael, @49

Greenspan goofed badly … and I’ll repeat the following (sorry) because I want to destroy the meme that “no one could see this coming, and the liberals are to blame anyway.”

http://www.newsweek.com/id/159346/output/print

~~~

Under the Home Ownership and Equity Protection Act enacted by Congress in 1994, the Fed was given the authority to oversee mortgage loans. But Greenspan kept putting off writing any rules. As late as April 2005, when things were seriously beginning to go wrong, he was saying that subprime lending would work out for the common good—without government interference. “Lenders are now able to quite efficiently judge the risk posed by individual applicants,” he declared at the time. So much for his feel. New regs didn’t get put into place until this past July—long after the crash had come, under Greenspan’s successor, Ben Bernanke. The new Fed chief’s “Regulation Z” finally created some common-sense rules, such as forbidding loans without sufficient documentation to show if a person has the ability to repay.

Greenspan has tried to defend himself repeatedly, though as bank after bank has failed he’s retreated to the shadows. But in a 2007 interview with CBS he admitted: “While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late.” This, from a man who once told me, in an interview, that he most enjoyed scanning economic reports for hours in his bathtub.

~~~

And we can attribute to Bush the pressure for zero-down FHA loans.

http://realtytimes.com/rtpages/20040120_zerodown.htm

52

Walt 09.24.08 at 9:09 pm

Sebastian, if you actually read the business pages, and not just the right-wing press, you would be better informed. I know that the hedge fund thing is supposed to be some devastating right-wing talking point, but for at least 6 months now participants knew that there was a serious chance that the whole banking system was going to collapse. This isn’t an ideological question about left versus right — actual participants in the markets knew that the worst case was pretty bad.

53

roger 09.24.08 at 9:16 pm

Actually, Sebastian’s point can be rephrased as – serious people, being highly paid and living the lifestyles common to the top 5 percent income bracket, were living in a huge bubble.

There is evidence for this all around. Take, for instance, the rightwing fierceness about insisting that incomes weren’t becoming more unequal over the last couple of decades, and much more so over the last eight years. The Freaks at Freakonomics, in one of those moments of UChicago hubris that could be used as a symbol of the Bush era, insisted that the glorious benefits of free trade, which made it possible for the poor to buy cheaper plastic goods from China, was a form of closing the inequality gap with the wealthy. Those lucky duckies and their plastic knicknacks! I wonder if banks take those things in lieu of mortgage payments? Well, one of the effects of denying that inequality is increasing is getting blindsided when an enormous effect from inequality rips across the economic landscape. If people were making less money, if we deduct inflation, in 2006 than in 2000, they had evidently at the same time taken on enormously more debt. And the debt they were taking on was not causing financial institutions to go, holy shit, but rather, to offer ever more teaser rates, under the benign eye of the Bush administration. Serious people are, in the media sphere, people who make good money to deny that 2 plus 2 equals 4. Less money for the average person plus skyrocketing house prices equals either a massive meltdown of those prices, with all its consequent effects on the system of debts contracted by the average household to keep up a lifestyle in excess of its income, or… or maybe the rapture.

We live in the age of the magic condition, which is how the “serious” are never able to question their own vanity. Thus, war supporters liked to say, in 2007, I supported putting in more troops from the very beginning, without saying, I supported the invasion regardless of the fact that my magic condition wasn’t met, and wasn’t about to be met. Similarly, the magic condition of the liberals is now, well, we have to do the bailout if we put in place regulations and institute much higher progressive taxes, knowing that, of course, these aren’t even on the table and are unlikely to emerge from the people doing the bailout. It is all very sad.

54

Righteous Bubba 09.24.08 at 9:34 pm

I have two brokers in the family. Both were aware of the situation at least a couple of years before the crunch came.

55

Sebastian 09.24.08 at 9:40 pm

“Sebastian, if you actually read the business pages, and not just the right-wing press, you would be better informed. I know that the hedge fund thing is supposed to be some devastating right-wing talking point, but for at least 6 months now participants knew that there was a serious chance that the whole banking system was going to collapse. This isn’t an ideological question about left versus right—actual participants in the markets knew that the worst case was pretty bad.”

Ummm, I don’t read any right-wing press. I have no idea what the right-wing talking points are, but I do know that a huge portion of the focus of the left-wing talking points were focused on things that had nothing to do with the crisis–weak dollar, oil prices, hedge funds. The worst case scenario is always pretty bad–see asteroid.

I’m not at all saying that NOTHING could be done. I’m saying that this concept that were lots of obvious things that should have been done is ridiculous. Even now you couldn’t get some of the most obvious things through–a mandate for large (20-30%) downpayments, for example.

56

lemuel pitkin 09.24.08 at 9:40 pm

Dean Baker has been writing about the housing bubble for umpty-odd years. Nobody who read his stuff could be shocked at what’s happening now.

57

Righteous Bubba 09.24.08 at 9:43 pm

Ummm, I don’t read any right-wing press. I have no idea what the right-wing talking points are, but I do know that a huge portion of the focus of the left-wing talking points were focused on

Walt was suggesting reading the business pages.

58

Michael 09.24.08 at 9:50 pm

Sebastian, that is NOT what you were arguing. You were arguing that the collapse of these financial institutions could not be predicted. Specifically, by Paulson and about AIG. That is demonstrably wrong. Your insistence otherwise based on nothing more than the fact that you are unaware of such things is ludicrous in the extreme.

59

John Quiggin 09.24.08 at 9:56 pm

The hedge fund thing is amazingly lame, even by the standards of rightwing talking points. Anyone who’s been following the issue at all (obviously not Sebastian) would know that it was the failure of Bear Stearns’ hedge funds in 2007 that signalled the spread of the crisis beyond the subprime mortgage market (and ultimately helped bring down BS). And right now, hedge funds are in a world of pain, with reports of massive redemptions. Of course, since hedge funds aren’t regulated, these reports are anecdotal, but you can expect to see lots of them shutting up shop over the next year.

60

Nur al-Cubicle 09.24.08 at 9:56 pm

It’s one thing to be a doom-sayer and quite another to be a doom-doer, as Wall Street has done. We’re screwed treated woefully by our elite. That’s what hurts. Done in by a bunch of Bertie Woosters with no clever manservant.

61

abb1 09.24.08 at 9:59 pm

People made jokes about weak dollar and said that it’s (obviously) a symptom of weak economy, but I don’t remember any left-wing talking points declaring the weak dollar a problem by itself. And as far as high oil prices go – left-wing talking points were very positive about that.

62

Markup 09.24.08 at 10:01 pm

Overheard on the left wing media, Speaker Pelosi has just declared the foot is being put down, no more rubber stamp Congress like Bush has been used to. They will look in to this to protect US.

I am much relieved.

63

John Emerson 09.24.08 at 10:31 pm

We really need to be humble about the limits of human knowledge and control.

We should not presume to know the ways of the Lord. People predicted a disaster, and we have a disaster, but correlation is not causation. For another example, look at “global warming”. Nobody really knows what will happen, much less why. In both cases, were we to put ourselves in God’s place and attempt to predict and control the future, we would be very likely to do more harm than good.

64

Michael 09.24.08 at 10:37 pm

Well, no doubt you will now offer up a reasoned critique of the arguments about causation that demonstrate why acting on the basis of such analysis would do more harm than good. Otherwise, why should we take your word for it that known negative consequences are less problematic than the unknown negative consequences of actions to address them? Or do we just let God sort it out?

65

John Emerson 09.24.08 at 10:41 pm

62: Can we trust Lucy this time?

66

Walt 09.24.08 at 10:42 pm

Michael, I believe joke-detectors are now available via mail-order. :-)

67

John Emerson 09.24.08 at 10:42 pm

Or do we just let God sort it out?

He’s God for a reason, Michael.

68

Michael 09.24.08 at 10:49 pm

But where Walt? [acknowledging the need]

Humble apologies John.

69

John Emerson 09.24.08 at 10:58 pm

Both Dave Barry and Carl Hiaasen have talked about how difficult it is to exaggerate contemporary stupidity. They’ve specifically had Florida in mind, but with the 2000 election Florida took over the whole nation.

70

engels 09.24.08 at 11:00 pm

If you really want people to be more humble in the face of their human limitations and failings, not allowing them to award themselves million dollar bonuses year in, year out might be a good place to start…

71

sg 09.24.08 at 11:38 pm

the people at the blogs The Big Picture and Calculated Risk and Sudden Debt have been talking about this for years. Clive Hamilton and Ross Gittins (a journalist, for god’s sake!) have been talking about it in Australia for years (I think I read Gittins’ first critique of the mortgage market 3-5 years ago). I remember talking to a trader in 2004 who told me he was waiting for the mortgage market to collapse so he could buy lots of his mates’ houses for nowt.

Just shows how much libertarians like Sebastian read outside of Reason magazine, I suppose…

72

John Quiggin 09.24.08 at 11:46 pm

Here’s my version from 2002, which I cited here on CT not long ago.

http://www.johnquiggin.com/archives/000133.html

73

Markup 09.25.08 at 12:20 am

65> ”Can we trust Lucy this time?”

You did last time? Tsk, tsk. I may have to take you off the table, too.

Just remember a robust economy requires an equally robust bailout. But on the bright side, the bathtub up to the overflow now; won’t be long.

74

ScentOfViolets 09.25.08 at 12:45 am

A couple of points here: I think that by now that ‘who could’ve known’ defense, especially when coupled with the ‘the only reason you’re right is because of a lucky guess’ defense is becoming rather shopworn; even the true believers don’t seem to able to muster up enough energy to pretend to to believe any more.

Also, notice how we’ve been exposed for years to a constant parade of ‘smart guys’ from the right; the one common denominator is that they really weren’t terribly smart at all, much trumpeting in the MSM to the contrary. Karl Rove was not smart; he was ruthless. And he had the support of the media. Alan Greenspan was not smart. His verbal meanderings were not oracular, they came from much the same sources as did Chaunce the Gardiner’s. But he had the support of the media. Paulson? I keep hearing that he’s smart, that he’s serious, that he’s got some tremendous horsepower and torque up in that dome of his. I know this because the media tells me. Not because, as Krugman notices, because of any particular set of actions.

Finally, I think it should be made a precondition for any company receiving aid from this bailout that their corporate chieftans must appear live on prime time TV and publicly admit that they were not worth their (extremely) high compensations. They must say that their performance had nothing to do with their pay, and they must apologize for the way they have run things.

They can keep their damn loot.

The problem, you see, is not that no one could have forseen these series of crises, but that the people who were right, right all along time and again, were still shut out of any real say on how things were run, even after it was more or less acknowledged that they were right. In contrast, the people who were wrong were still firmly grasping the levers of power, ala invading Iraq. Indeed, the only ‘serious’ people were deemed to be the ones who were wrong, but who grudgingly admitted without being specific that ‘mistakes were made’. Though of course, ‘who could have known’ beforehand?

75

John Emerson 09.25.08 at 1:26 am

Greenspan and Rove were smart. That’s one of the reasons they won. But they’re just bad.

Rove had one year of college, but he had a lot of PhDs working for him, and he whipped up on a lot of Democratic PhDs. Their belief in credentialization kills the Democrats.

Greenspan wasn’t fully credentialed either. He’s an ABD at best, IIRC,

76

J Thomas 09.25.08 at 2:25 am

Ummm, I don’t read any right-wing press.

Ah, you make it up all by yourself then. A sort of convergent evolution.

I have no idea what the right-wing talking points are, but I do know that a huge portion of the focus of the left-wing talking points were focused on things that had nothing to do with the crisis—weak dollar, oil prices, hedge funds.

Wherever did you get the idea those things had nothing to do with the current crisis? Do you have any evidence that they aren’t central to the current crisis?

Weak dollar? There’s money to be made in this mess if the feds don’t pay for it, but the people who could do it would have to convert to dollars. And they have every reason to think the dollar will get weaker. So they don’t. Etc.

When you use the right-wing talking point that claims our various deep problems are unrelated, you are trying to make us stupid.

It bothers me the extent that you succeed. Lots of people like to waste time knocking down your stupid arguments. I do it myself. But it’s an utter waste of time. It’s like, you could argue that the world is flat, and people would have great fun, they knock down your arguments and congratulate themselves for beating the stupid Republican, and what is it worth? It’s even tactically useless — if there are people who vote Republican who want to believe the world is flat they’ll go right on believing it and go right on voting Republican regardless of the discussion here. Mostly, replying to you is a stupid thing to do.

But people do have fun responding to you. I can’t really say they should stop. Just — do it moderately? Maybe one response to Sebastian per person per thread? Maybe also one response to Sebastian per person per day?

77

mega 09.25.08 at 2:51 am

giving people like Sebastian a pass is exactly how we got into this mess in the first place. It is how patently ludicrous claims survive in the public sphere. I say let him, and anyone else who wants to insist on the vapid, craven, or dogmatic, have it.

78

ScentOfViolets 09.25.08 at 2:59 am

John, what evidence do you have that either is smart? I can produce posts from 2004 where I note that it’s easy to be ‘brilliant’ at campaign strategy if you’ve got the press in your pocket. If you don’t, or if they are actively hostile, not so easy. Can you point to anything Rove has done that shows great acumen? Or will it turn out to be merely completely unscrupulous backed by a complaint media?

The same for Greenspan. Or for that matter, the whole conservative intellectual firmament. What people like him were good at, what they were rewarded for, was for telling certain powerful people exactly what they wanted hear. In short, they were skilled at court flattery in that they were able to give it a minimal patina of ‘scientism’. I don’t see much more than that.

Oh, and yeah, Sebastian is fun to tweak. Let me do my bit and ask how many people here think that 20% down on a thirty-year mortgage is ‘high’? That’s how I financed my house back in 1998, and I was under the impression that even then that was still the industry S.O.P. If anyone thinks that 10% down is more typical, I would guess that they don’t have a lot of experience in the housing market. Perhaps they are too young to have much.

79

John Emerson 09.25.08 at 3:13 am

SoV: For me smart is a neutral word, like”tall”. And in general, losers can’t call winners “stupid”. We’re the losers, they’re the winners.

A friend of mine in Pol Sci from a statistical point of view was in awe of the Republican campaign machine. Rove wasn’t solely responsible for it, but he played an enormous role.

As for Greenspan, Brad DeLong has an enormous respect for him. He once said that the seven times he disagreed with Greenspan, Greenspan was right four or five times and wrong one or two times, with one draw.

80

ScentOfViolets 09.25.08 at 3:27 am

That’s all well and good, John, but you’re just offering up opinions, not facts. And no, opinions of other people are not facts.

Note also that I did not say that Rove was stupid. That’s something you put in yourself. I merely said he didn’t have the smarts certain people would like to credit him for.

So what’s your evidence that Rove really is smart? The specific actions, not word of mouth assessments, please.

81

Sebastian Holsclaw 09.25.08 at 5:50 am

“If you really want people to be more humble in the face of their human limitations and failings, not allowing them to award themselves million dollar bonuses year in, year out might be a good place to start…”

Absolutely. I’m a huge bailout skeptic. Maybe you didn’t read early enough in the thread, but my default vaule is that any and all losses that won’t lead to collapses hitting 3rd parties ought to be bourne as much as possible by the equity and bondholders.

That has nothing to do with how predictable this particular mess was and it really has nothing to do with whether or not this mess was preventable by any realistic countermeasures that could have been implemented prospectively.

A lot of this has to do with marking assets to market–something I would have said was a great thing 30 days ago. Under the old system, assets would have been carried until they could be sold for a profit again. Sometimes that would never happen. Failing firms could still attract capital over a long failure because of that. I, and lots of other people with more power than me, thought that it was better to have those firms fail, rather than let them suck up good capital on their way to failing.

But as it turns out, the rule also caused failures in firms that didn’t really have a reason to fail. If AIG could have just held its assets for a year or so through the crisis without marking them to the fire sale market prices, that would have been better.

Unintended consequences often suck.

82

Roy Belmont 09.25.08 at 6:15 am

Money and I have a very tenuous relationship at the best of times, but the picture looks a lot like these companies are in trouble because they made loans (or bought them from those who made them) that were unsecured and unlikely to be repaid.
So the American taxpayers are being asked, forcefully and with threats of imminent doom if they don’t, to give them loans which are unsecured and unlikely to be repaid. Only with lots more zeros.

83

abb1 09.25.08 at 7:25 am

Overheard on the left wing media, Speaker Pelosi has just declared the foot is being put down, no more rubber stamp Congress like Bush has been used to. They will look in to this to protect US.

Sarcasm, I presume?

84

glenn 09.25.08 at 7:36 am

…and not one word about the recent money market problems? Maybe very, very few people really get it at all…

85

J Thomas 09.25.08 at 10:55 am

giving people like Sebastian a pass is exactly how we got into this mess in the first place. It is how patently ludicrous claims survive in the public sphere.

No.

Patently ludicrous claims survive because the media repeat them and take them seriously.

If you seriously debate them, then that’s part of it. The media will at best report the debate and announce that opinions differ.

If you debate them on CT nothing will happen except that you will have that much less time available for serious concerns, and everybody who reads your comment will have that much less time available.

On the other hand it might be a sort of useful stress relief, in moderation.

86

John Emerson 09.25.08 at 11:55 am

SoV: You’re a loser talking big. You remind me of the nobody I read recently who was bragging that his SAT scores had been better than Obama’s. You also seem to have an undue admiration for smart people. Lots of crooks are smart.

I won’t link DeLong’s argument that Greenspan was smart. I would if I thought you were worth bothering with. He was quite specific and detailed, and DeLong is a credentialed and experienced economist whose writings I admire.

My friend was doing academic work in more or less the area where Rove does his political work, and his judgment was that Rove is smart. Against this what do you bring to the table? Knee jerk skepticism. No reason for me to knock the chip off your shoulder.

87

ScentOfViolets 09.25.08 at 12:51 pm

Uh, John? I’m a physical sciency type of dude. I’m all about the evidence. Facts. If these people have facts that support them, why not repeat the facts that they base their opinion on? Not assessments.

As an aside, on one particular blog certain posters were sneering that the ‘lefties’ were right about the lack of WMD in Iraq, but they were only right by accident, and more in hindsight when they made their objections more forceful than they really were at the time. When I pointed out that no, that just wasn’t so, I was subjected to the usual stock in trade, derision, and was asked how I could be so sure when others much smarter(ha!) and much more in the loop than I got it wrong.

To which I replied: physical evidence. The aluminum tubes that were supposedly being used to produce nuclear weapons turned out to be categorically unsuitable for this use. The ‘yellowcake documents’ that were supposed to be so damning as to intent were cheap and obvious forgeries. The same thing with the ‘germ factory’.

Iow, by not listening to the opinions of others, often stove-piped and always repeated in an echo chamber, and by considering only the physical evidence, I was entirely justified in my skepticism. And entirely right.

No, opinions, well, you know what they say about them. I don’t hold with ’em much myself. Physical evidence, tangible actions, that sort of thing? That’s about the only thing that matters. You ought to try it sometime.

88

J Thomas 09.25.08 at 1:14 pm

… certain posters were sneering that the ‘lefties’ were right about the lack of WMD in Iraq, but they were only right by accident, and more in hindsight when they made their objections more forceful than they really were at the time.

They were right.

How could anybody have known that our WMD searchers were so honorable that they refused to plant the evidence? We had prominent iraqi nuclear scientists etc in Gitmo for 2 years before we admitted there were no nukes there. That’s plenty of time to get full detailed confessions. But the confessions were worthless when no evidence had been planted.

Who could have predicted in advance that our soldiers would be so honest? It was sheer luck that we wound up believing there were no nukes in iraq, instead of believing that there were.

89

Markup 09.25.08 at 1:59 pm

83> “Sarcasm, I presume?”

Not at all. Faint optimism. If it happens, then I’ll faint.
Sarcasm would be considered to be shallow or something, right?

90

abb1 09.25.08 at 2:15 pm

Ah. Then, instead of “They will look in to this to protect US“, I suggest: “they will see which way the wind blows to protect themselves.”

91

Donald Johnson 09.25.08 at 2:26 pm

#88

My sentiments exactly. I was genuinely surprised that our government didn’t either plant evidence, or else find a few rusting barrels of toxic waste and claim those to be the much-dreaded WMD’s.

92

Markup 09.25.08 at 2:56 pm

90> They are US, too.

I know it’s not April, but is the clock striking 13?

93

John Emerson 09.25.08 at 3:10 pm

SoV: all you’ve offered is your own assertion that Rove and Greenspan aren’t very smart. I’ve referred to two people I respect more than I respect you who are familiar with the fields they work in who say that those two guys are smart, and what they say confirms my own opinion and that of many others. Since you’ve brought nothing to the table, that’s enough for me. You seem to think that your opinion that they’re not smart should be the default assumption to be rebutted, but it isn’t. It’s your baby.

You say: “No, opinions, well, you know what they say about them. I don’t hold with ‘em much myself. ”

This is baffling. On Rove and Greenspan you’ve offered nothing but your opinion.

It doesn’t make a lot of difference whether we conclude that those two guys are smart. They’ve been playing at a very high level, and they’ve won, and they’ve transformed America. I think of them as malignant, but see no reason at all not de say that they’re smart. If they had done what they did with 98 IQs and high school educations, that would be downright weird, but it wouldn’t change anything.

I’m not really trying to convince you; go in peace.

94

ScentOfViolets 09.25.08 at 4:39 pm

No, John, I’m not offering up some flat declaration. Other people are saying that they’re smart. I’m saying “Oh, yeah? What’s your evidence?” This is much the same as devout people insisting that the claims of atheists are ‘just as religious’, just a much a matter of faith to the contrary. Well, no. Not exactly. Most atheists I know make claims along the lines of “I see no proof for the existence of a God or Gods”. Very few actually flatly declare that ‘God does not exist.’ It’s a sciency thing again, I guess. Most scientists will readily concede that there’s a possibility that the theory of evolution is not the best theory, and will equally readily concede that Creationists might be correct. They will usually assign small probabilities to these two cases, but they won’t flatly say that the probability is zero.

Something else that’s been bothering me:

You also seem to have an undue admiration for smart people. Lots of crooks are smart.

Could you please tell me where you get this. Now, I’ll readily concede that I may placed an undue emphasis on being smart . . . about 30 years ago. These days, I’m much more impressed by qualities like honesty and willingness to work (it’s been my experience, even in the rarified world of mathematics, that the myth of raw talent gets severly overworked; what counts, as in other places is the amount of work one puts into some project. I’ve seen people who I’ve thought not terribly talented publish outstanding work. And I’ve seen what at first blush appear to be extremely gifted individuals who piddle around not doing much of anything. The difference? The former worked very, very hard, putting in sixteen-hour days for weeks at a stretch. The latter didn’t. Thinking, as they always had that they could fall back on that resevoir of ‘raw talent’. No. You really can’t.)

95

John Emerson 09.25.08 at 5:41 pm

SoV, some of the people who say Rove is smart say so for the same reason a lot of boxers said that Marvin Hagler was tough. These people once thought they themselves were smart, but they went up against Rove and found out that they were dumb. Rove’s political goals are horrible, and his methods are semi-criminal, but he’s smart.

96

roger 09.25.08 at 5:44 pm

To get back on track to economics – James Galbraith’s op ed piece in the Washington Post pretty much nails what the liberal response to Bush should be. If the Dems were smart, they would make it their manifesto.

97

TheWesson 09.25.08 at 8:18 pm

I got interested in this subject (mortgage / CDO crisis) mostly because my brother, who is an MBA and worked doing finance in Silicon Valley, has been telling me about the impending crisis for a couple of years now – it’s a hobbyhorse of his.

This is what I understand:

“Virtual” wealth (no value added from labor or other resources) has been created at a great rate by the housing bubble. When this virtual wealth goes away, anybody who was relying on its existence (homeowner with HELOC’s, WaMu bank, CDO sellers, people using CDO’s as collateral) is in a world of pain.

It is very easy to spot a housing bubble based on some simple fundamentals, such as median house price to median income. Hence the disaster warnings from my brother for the last two years.

The part I don’t really understand:
The boom was driven by huge expansion of credit. Such a boom has to end with either – inflating the problem away with consumer inflation (debasement of the currency), which would diminish debts and as a side effect make house prices rational again eventually – or a massive contraction of credit, deflation, and a severe recession/depression. Since our Gov’t cannot allow a severe contraction of credit, it is now effectively choosing, by doing bailouts, the debasement of the currency, which takes us to a future of stagflation.

It is regrettable that in the new regime of currency debasement the Chinese may no longer desire to buy dollar-denominated US Treasury bonds, which I understand is a very bad thing indeed.

98

Watson Aname 09.25.08 at 8:43 pm

But as it turns out, the rule also caused failures in firms that didn’t really have a reason to fail. … If…that would have been better.

I’m not convinced this is true. The entire approach is broken, these companies aren’t the victim of bad debt; they are paying for bad ideas and practices. If it takes a few dramatic failures to smarten the rest of the up, are we really so much worse off? When you’re talking about a pretty much global failure, you’re unlikely to be able to distribute the pain completely equitably, regardless.

99

Barry 09.25.08 at 8:48 pm

Comment – Sebastian is a corporate lawyer, and has spammed the living crap out of another thread, when it concerned things in his professional purview (sp?); the Ledbetter thread. It’s likely that he’s doing the same here; the tactics are similar. Ignore him.

100

Michael 09.25.08 at 10:06 pm

Sebastian is overpaid and I can say that with confidence without knowing how much he is paid.

101

J Thomas 09.25.08 at 10:07 pm

SOV, yes, until we define what it means to be smart then we’re only talking 0pinion about who’s smart. John Emerson is using it in a colloquial way, calling somebody smart if they’re successful at something.

As to whether Rove was smart or had a simple pattern that worked and also he got lucky, we’ll have to wait for historians. Like, if he was involved in passing forged information about Bush’s military records to Dan Rather and then later exposed the forgery, I’d have to say he was pretty smart. But if he didn’t plan it then I guess he was just lucky.

102

Markup 09.25.08 at 10:44 pm

Would one consider a person who smeared grease on pie pans ‘smart’ ?

Does the equation change if that person was able to make say $150k a year doing it?

103

John Emerson 09.25.08 at 11:40 pm

This is really silly. Rove is smart by any standard. He’s uncredentialed, he may be uncultured, he may be no fun, but he’s smart. He’s in a ruthlessly competitive business where people don’t have successful careers by luck, and where outwitting the other side is what wins the game, and where knowing a tremendous amount of detailed information was required. He might even do poorly in a grad school seminar on voting behavior, but when the PhDs who aced the class went out into the world with their doctorates, if he didn’t hire them he’d whip their asses. I came to this conclusion after talking to a guy whose dissertation was was in part on voting behavior.

There’s an alternate, purely academic definition of “smart”, but that’s an inferior definition because it describes bright, clueless, highly verbal people as smart.

104

ScentOfViolets 09.26.08 at 1:09 am

Sorry, but in my opinion conflating what works (dependent on large part with what one can get away with) with smarts is not part of _my_ operational definition. Nor do I consider doing unprincipled things with being ‘smart’. If you wish, _you_ can say that the Swiftboating thing was evidence of smarts – smarts in the so-called real world sense even.

_I_ don’t. I call that despicable, and relying on an eagerly complicit media to spread such nastiness. Kinda helps to have the media ready, willing, and eager to disseminate your propaganda while suffocating the other guy by refusing him equal air time. No, that’s not particularly smart.

Maybe you’re thinking of when Rove blanketed South Carolina with ads describing how McCain had a black child out of wedlock, that he was a closed homosexual, etc. This is what you think is evidence that Rove is ‘smart’? Again, to me, it looks an awful lot like ‘unprincipled.’ Not something that was particularly inspired or the result of some cerebral heavy lifting.

But . . . if that’s your definition of smart, well, okay. All I can say is, it’s certainly not mine.

105

John Emerson 09.26.08 at 2:13 am

As I said, SoV, for me “smart” is morally neutral.

Evil does not necessarily prosper, but Rove sure did. There was an additional ingredient.

You are a moron, only in part because you do not understand why Rove was successful.

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J Thomas 09.26.08 at 3:44 am

Kinda helps to have the media ready, willing, and eager to disseminate your propaganda while suffocating the other guy by refusing him equal air time. No, that’s not particularly smart.

If you happen to be lucky enough that all the odds are stacked on your side, then you can win without being smart. Doesn’t say how smart you are then.

One of the most encouraging signs I see these days is National Enquirer is publicising up Palin and McCain scandals. If NE has deserted the GOP, can Fox News be far behind?

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Roy Belmont 09.26.08 at 5:28 am

ScentOfViolets:
Words like “crafty” are employed to get the distinction you and John Emerson are foundering around about.
Despicable smart people. To the outraged the despicable aspect outweighs any intelligence demonstrated.
But there’s a lot of admiration out there for those who can play the system to achieve their ends, regardless of what those ends carry, morally.
Rove is crafty enough to get Machiavellian trophies.
It’s an old debate. The devil, in Christian mythology, is the craftiest of all beings. Sort of has to be, if you think about it.

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john in california 09.26.08 at 7:26 am

In 2002 my brother told me this was going to happen and he’s just a retired scientist that spends an hour or so in the morning studing his stocks and paying attention to the constantly inflating prices of his SoCal neighbors real estate. My point is that it didn’t take some esoteric knowlegde of finance, just a common sense view of value vs income vs expected return on the lender’s investment. No way it could add up.

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John Quiggin 09.26.08 at 10:21 am

To go right back to the beginning, when I said “stipulate that Paulson is smart”, I kind of had the idea that we shouldn’t spend 100 or so comments on this point, since it doesn’t really matter whether he is smart or not.

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George Peabody 09.26.08 at 4:45 pm

So, my question: is Paulson smart enough to have seen this coming a couple of years ago and followed a personal strategy that allowed him to cash half a billion out of Goldman without paying taxes, and place himself in a position to control $700 billion with which to bail out his buddies?

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bartkid 09.26.08 at 6:41 pm

>Let’s stipulate that he’s a smart guy.
I dispute that claim. I forced myself to listen to the 2 hours and 19 minutes of congressional questioning of him, Bernake, and Cox on C-SPAN. He may be smarter than Boehner and McCain, but Mr. Paulson came across as less swift than everyone who questioned him.

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J Thomas 09.26.08 at 7:39 pm

It is regrettable that in the new regime of currency debasement the Chinese may no longer desire to buy dollar-denominated US Treasury bonds, which I understand is a very bad thing indeed.

TheWesson, this is the part that I think isn’t getting enough attention. This is what it was about all along.

Look at our balance of payments. Look at the exchange rates for currencies that aren’t pegged to the dollar.

Since 2003 or so, the US dollar has lost about a third of its value against the euro, the hungarian forint, the brazilian real. It’s gained a bit of that back in 2008. How can you have a dollar be worth 2/3 what it was on one market, and worth just as much as it used to be on another? Is that cause for currency speculation? No, the currencies that are pegged to ours fall into two groups. There are countries that vitally depend on exporting to us — if they can’t export to us they get massive unemployment and social unrest. So they are basicly subsidising their exports, they sell very cheap so that their workers can continue to work hard at low-paying jobs. And then there are countries that are waging economic warfare against us.

Our trade balance continues to stay unbalanced. So we need foreigners to loan us money. If we want to continue our imports we need lots of loans.

There’s a market in T-bills, but for various reasons we set the interest rates on them very very low. We cannot finance our imports that way.

So we came up with the idea of selling mortgages on homes. We persuaded foreigners with money that these would not default, that they were almost as safe as T-bills but they got much more interest. Foreigners bought lots of US houses, in big groups so the risk was spread out.

We decided that US houses were getting more and more valuable. Americans could buy a starter house and sell it pretty quickly for considerably more money. Then they’d owe taxes on their profit unless they bought a more expensive house. So they bought another house that was worth more, and then sold it. The prices kept going up so we could get more money from foreigners to finance the same houses. Also we built new houses. We found more people to live in the houses and get mortgages. And this kept going until the foreigners decided they didn’t want any more US home mortgages.

When the money dried up people had trouble getting new larger loans for their houses. So the houses stopped increasing in value. Many of them declined in value. We couldn’t use that collateral to get loans from foreigners any more.

Then the companies that were supposed to sell mortgages to foreigners were in trouble. They had a lot of merchandise that they couldn’t move. They were in immediate trouble because they were supposed to value their unsold inventory by “mark-to-market”. They were supposed to say it was worth what they could sell it for, which was something like 10%. If you look at it another way they shouldn’t have to do that. If they just hold onto the mortgages themselves, something like 94% will probably come out fine. So they should be worth 94%, not 10%. Similarly, back when Ford had a whole lot of unsold merchandise they could have turned it all into company cars and profited that way.

So anyway, the companies who can’t sell their houses to foreigners at anything like the price they want are in trouble, and they want the US government to buy their unsold inventory.

So what are we going to do for foreign exchange? What can we do to get foreigners to keep giving us money? Unless we find something we’ll have to depreciate the dollar a lot more. Imports will get more expensive. There may be a big surge in exports as foreigners buy up our cheap lumber, coal, oil, wheat, etc. Note that as food gets cheaper for foreigners to buy from us, it gets more expensive for use to keep for ourselves.

What about oil? If things get bad enough at some point we will switch from being an oil importing nation to an oil exporting nation. Oil is fungible, it gets shipped to those who can pay.

The immediate crisis — the stuck credit market — is a publicity stunt. It’s hard to get foreign credit because foreigners no longer trust the dollar or US collateral. But the Fed can provide as much liquidity as they want. Within very broad limits they can print money. Nobody needs to do without a loan just because foreigners don’t loan us the money.

The bigger crisis — the trade imbalance, that might get balanced for us against our will — that one is serious.

But I don’t understand the issues. Why has the US dollar gone up since January 2008? Makes no sense. Who could afford to buy large numbers of worthless dollars and store them, at this point?

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TheWesson 09.26.08 at 11:09 pm

Thanks for the analysis, JThomas.

The Chinese are still buying US dollars in the form of Treasury bonds at this point, I believe? They are “paying” for them with their exports, subsidizing our lifestyle in the process.

James Fallows from The Atlantic seems to have thought about these issues …

http://www.theatlantic.com/doc/200801/fallows-chinese-dollars

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TheWesson 09.26.08 at 11:22 pm

“Smartest Guy in the Room” might be suffering under a wrongheaded philosophy, or a philosophy which is wrong for our current situation.

See Brad DeLong on Greenspan’s reasons for not trying to tamp down or limit the housing bubble … abjuration and penitence from DeLong…

http://delong.typepad.com/sdj/2008/09/delong-smackdow.html

Back to the original topic …

Now, I don’t know what Paulson’s philosophy is, but maybe he should be sacked, simply because he has gotten the situation so wrong for a year and a half. Maybe his guiding philosophy about this is half- or non-baked.

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