When Bad Things Happen to Good People Because of Bad Things done by Good People … A Morality Tale (or is it?)

Although it’s had all sorts of twists and turns, at the end of this story, I’m not judging the main characters to be either heroes or villains, because economics isn’t a morality tale.

The post cut off the last line, which was evidently supposed to be “P.S. – this means me.”

As an Australian, I read this blog with wide-eyed horror a couple of years ago. Although we don’t have such an animal and I was unfamiliar with the workings of it, “Option ARM” appeared regularly as an instrument of homeowners’ demise.
We do have the phenomenon of homeowners using repeated additions to their mortgage loan to finance consumption, but so far we seem to have escaped the worst financial products and consequences seen in the US.

Daniel – this generalises well: current account imbalances really are the closest thing to a root cause of the various financial mishaps that have beset the US and the Eurozone in recent years.

economics isn’t a morality tale.

Okeydoky. How about politics then? Can we judge the politicians who deregulated and the lobbyists they responded to and the regulators they appointed to as heroes or villains?[1] Or is this just a case of the free market at work and thus also not a matter for morality? Is it okay to apply notions of morality to anything other than sexual acts or consumption of drugs, or must we limit them to those situations?

The last incidence of “they” in this sentence is deliberately left ambiguous &/or obscure. Interpret it as it suits you.

Er yes, peaked. Sorry.

It isn’t an argument, it’s a story. The argument was in my last post (and in another, better one that I wrote somewhere else and didnt publish here because I was ticked off with you lot)

I buy the massive imbalance is going to be intermediated story (used to hear a lot about that back in 2004. Whatever happened to Brad Setser anyway?) I’m curious about the political-economic reasons for why the imbalance exists in the first place. Dean Baker hints at it when he talks about the Rubinite strong dollar policy, but it’s not obvious to me why a strong dollar is good for Wall Street. I saw a quote from Geithner about a year ago where he says that that America is only good at finance so our industrial policy should be based around finance (as if China and India aren’t smart enough to have their own banks) but I can’t find the reference.

Imbalances can’t be the whole story. Japan had a current account surplus before and after its banking crisis. The US had a current account deficit before and after its banking crisis.

And doubly so if the official policy of the central bank at the time is to create a housing market boom, and the official anti-bubble policy of the central bank is to allow the bubble to grow, on a promise that action will be taken to mitigate the consequences when it pops.

huh? So the housing bubble wasn’t created by individual malfeasance enabled by lack of regulation, but instead by intermediation of a current account surplus enabled by regulators who actively wished to create a housing bubble and so presumably overlooked individual malfeasance…OK, I give up. The main complexity in this story is D-squared chasing his tail.

DD notes: This comment is a prime candidate for deletion, but I’m going to let it stay purely because it provides the occasion for a bit of exegesis of the comments policy. Note that MQ hasn’t sexually or racially abused anyone here, so the recent changes to the policy are not relevant. On the other hand, this comment does not contribute to the discussion at all. It’s just a blanket declaration of personal incredulity, followed by a mild and slightly incomprehensible insult at me. As a result I would tend toward deleting it, and if MQ made a habit of such comments (as he/she in fact does, and has been warned for it in the past by other editors) I would at this point be considering whether a ban was appropriate. I also note that MQ has not provided an active, working, genuine email address (a general requirement for commenting on CT) and I ask him/her to do so in future, when posting his/her comments in the new, polite and interesting style that I expect him/her to adopt.

“With the best will in the world, as I say, if there is a massive imbalance in the real economy (in this case, the decision to accommodate Chinese exchange rate policy and run a consequent current account deficit), there will be a similar imbalance in the financial sector which intermediates it (in this case, equilibrates the resulting capital flows). ”

Isn’t this the story in Europe right now? Yikes.

“And doubly so if the official policy of the central bank at the time is to create a housing market boom, and the official anti-bubble policy of the central bank is to allow the bubble to grow, on a promise that action will be taken to mitigate the consequences when it pops. ”

Ackk, I thought you said earlier that this was largely a lack-of-regulation problem. But here you strongly suggest that it is a regulators-gone-bad problem.

It could be both, of course, but if the super-smart-technocrats can screw something basic like that up, what hope do we have with increased regulation?

(Note, I really do believe that regulation of the banking sector is both necessary and possible. But it will be through simple things like leverage controls.)

I don’t understand why you have a problem seeing the sandlers as un ethical
Is it disputed that they originated the Pick a pay, sort of crack cocaine of mortages ?
Is it disputed that they sold their company to a large amoral bank – thereby exposing both their current customers , their employees and their future customers (those lured in by the sandlers rep) to bad practices ?
you do good, and then sell you company to someone who is bad, you don’t get a pass (isn’t there a bank robbery movie with Denzel Washington and J Foster about this)
I think it was Pope Pius VII, who upon his election was being shown around the vatican.
He stopped to talk to a gardener, who told him that the vatican paid so little, he couldn’t afford to feed his family.
The pope turns to his cardinals and says we have to raise wages.
The cardinals say, but we will have less for charity.
And the pope says, the punchline here
Justice before Charity

Daniel, Is it solely Chinese exchange rate policy which is the instigator, or do you employ metonymy? To rephrase your last paragraph, outsourcing has led to all sorts of profit accumulation abroad. Some of that money has become hot money, sloshing around the world, looking for high returns and safe harbors, or harbors presumed to be safe. Property bubbles in lots of places were to fit the bill, and certainly U.S. mortgage derivatives were lucrative enough to accept shoddy reasonings about the risks. Meanwhile the torpor of the ’90’s domestic U.S. recovery was masked, i.e. it looked better than it really was, because this international credit flow into housing over-construction, cash-out refinancings, and the wealth effect of higher equity, all served to prop-up the U.S. consumers, who of course were happy to go along. This, it seems to me, may have no singular villains (though frauds, it would appear, were rife at almost every level) and there is no one person or group to blame. But I disagree with your conclusion. It is an enormous morality tale.

@25:

I agree that Red China was not really in the pre-dominant drive’s seat and the whole East Asian Co-Prosperity Sphere 2.0 involves much more than China, but the agency-less account of CA imbalances isn’t quite credible, least of all if it reduces to “cheap manufactured goods”. That utterly elides the MNC/Hi-Fi economic rents that were/are extracted from the FX arbitrage involved.

Thanks for the quick and detailed answers, Daniel :)

Those were supposed to be bullet points.

Daniel wrote:

the bubble fundamentally wasn’t caused by deregulation.

Okay. But would better regulation (I know, might as well wish for a pony) have kept it from inflating, or inflating so much. Some possibilities, requiring:

– mortgage issuers to retain a share of every mortgage issued (skin in the game)
– financial firm bonuses to be based on a moving average of several years’ profits and to be delayed for 2-3 years until returns are in

Suggest others, I suspect you can come up with better ones.

Daniel also wrote:

it is certainly possible that a very, very different regulatory regime could have prevented real estate prices rising, but only at the cost of making 2001-2011 into a lost decade of its own.

If we are going to use bubbles to keep the economy out of recession, there are bubbles and bubbles. How much did the dot-com bubble directly impact the wealth of the lower 99%, or of the lower 80%? Employment in the US, by any measure I can think of, was better than it has been anytime since Nixon’s election in 1968, and this had widely distributed benefits for the U.S. It is not (necessarily) the case that preventing the real estate bubble would have ensured a lost decade in the aughties. The Fed could have identified other types of asset, ones that were narrowly distributed (like tech stocks in the nineties), and looked the other way as bubbles developed there. On the way up, there’s no reason to believe that employment could not have been stimulated as those holding or trying to hold that type of asset became increasingly giddy. On the way down, the collapse in a narrowly held type of wealth, would have had less impact on consumer demand.

Penultimately, about morality tales: yes, repeating you and Krugman, economics may not be a morality tale, but a tale based on morality is a political necessity, for gaining and retaining support and mobilizing people, especially when the minions of wealth and power use morality to support perverse, wrongheaded “solutions” to the problem.[1]

Finally, I echo Bill Kaminsky and am glad to see that you are back, posting and not just commenting. Any chance that you’ll remove the passport control kiosk on your own personal blog? I miss the (roughly) weekly dose of snark and analysis. (This is not meant to suggest that I regret or withdraw any opinions I expressed on your last post here in which, at the very least, you badly expressed the point you were trying to make).

[1] See Merkel, Angela and Party, Tea.

The Sandlers had been offering Pick-A-Pay for more than twenty years, including through one period of falling house prices, and it had worked out fine, because they had underwritten them sensibly and conservatively. Without the benefit of hindsight, I don’t think it can be sustained that negative amortisation was an intrinsically evil product.

Something here is bothering me, and I think it’s this: we don’t shy away from regulating dangerous products in other spheres, so why should we make an exception for financial products? All sorts of hazardous things can be used safely and successfully, given certain conditions; nonetheless, we don’t blithely put those things on the shelves for purchase by any and all. The best candidate for being the cause of a brush fire that wipes out a suburb might be an unusual lack of rain; nonetheless, it’s perhaps not a good idea for the suburbanites to be in the habit of storing drums of gasoline in their garages.

The great thing about negative amortization, pick-a-pay loans is that the bank recorded the amortization as earnings. Not making payments? No problem! We’ll just record your non-payment in our earnings, inflate the stock price based on those bogus earnings, and sell out at the top! Thank you very much.

No, the Sandlers are right up there with Angelo Mozillo among the villains. I don’t think they can really point to the trade deficit as an extenuating factor.

“At Oakland (Calif.)-based Golden West Financial Corp. (GDW ), which has been selling option ARMs for two decades, deferred interest made up about 59.6% of the bank’s earnings in the first half of 2006.”

Let’s assume honest accounting, ie recognize earnings only when the cash actually comes through the door. Would banks have been so eager to make these loans in that scenario?If the Sandlers had wanted to be honest and prudent bankers, they would not have recognized fictitious earnings.

1% and inflation: here’s where it gets weird though, because the 1% are generally not keeping their wealth in cash, surely, but in assets, and increases in the money supply should not of themselves cause the prices of those assets to fall behind other prices. Moreover, people who work in the financial sector should know this.

My theory is that it’s a tea-party like brew between the libertarians who think inflation is theft and those rich Republicans who’ve made money in politics rather than a free market (pork barelling, logrolling, campaign contributions, thinktanks etc)

But would better regulation (I know, might as well wish for a pony) have kept [the bubble] from inflating, or inflating so much.

I’m not dsquared, but I can’t see any way that better regulation of banking would have affected the bubble. What would have kept the bubble from getting to significant size would have been policies designed to keep leverage down at the household level, such as strict down payment requirements, retained equity rules for second mortgages, and so forth.

And those requirements were largely dropped because of the efforts of well-intentioned pro-equality groups, who saw 20% down requirements as something that reduced the ability of the less well off to own homes.

“Yes they would, or at least the Sandlers did.”

Actually, they didn’t. And the fact that their own compensation practices were at odds with their accounting is inculpating.

bjk, you don’t get to choose your accounting standards. You have to use GAAP, which is set by an accounting body. The fact that they chose to use much more conservative accounting policies internally is exculpating.

Evil is knowing the system is flawd and then dressing it up such that it is hidden. Only when you have somebody that concretely shows both (e.g. because he or she milks it for his or her personal gain) should we accuse individuals.

That’s why I give Cameron the benefit of the doubt I would no longer give to Blair.

“The Sandlers had been offering Pick-A-Pay for more than twenty years, including through one period of falling house prices, and it had worked out fine, because they had underwritten them sensibly and conservatively. Without the benefit of hindsight, I don’t think it can be sustained that negative amortisation was an intrinsically evil product.”

They did so for more than twenty years of unsustainably quick housing price increases, which included one brief and localized period of falling house prices that quickly bottomed out. They were selling primarily in California, the bubbliest of the bubbly states–in which the housing market bubble began well in advance of that of the rest of the country, and in the San Francisco Bay area, one of the bubbliest of the bubbly areas in the bubbliest of the bubbly states. They were promoting a product which absolutely depends on the property remaining bubbly or it explodes into a completely unmanageable mess.

They were not straight up crooked like for example Bernie Madoff, but like his Ponzi scheme, the real worth of it wasn’t discoverable until a recession caused the merry go round to stop.

In another vein, I have a bit of a time with the “blame the Fed” concept as if it were somehow completely divorced from the interests of financeers. Am I wrong in stating that the Fed pretty much gave the macroeconomic policy that the bankers wanted? Am I wrong in suggesting that the Fed gave the macroeconomic policy it did because the bankers wanted it?

So what is all this “Given that massive policy error, I don’t see the point in either a) speculating about what kind of cut-for-the-purpose financial regulatory regime might have had the effect of undoing the actual policy of the central bank and treasury of the time (in general, financial regulation is shaped toward the opposite goal), or b) blaming the banking sector specifically for not deciding to independently adopt their own monetary and exchange rate policy in opposition to that of the Federal Reserve.”

The Fed policy wasn’t developed in a vacuum. It, just like the regulatory regime, was designed by the bankers for their own profit. Public choice theory in action.

SamChevre 12.13.11 at 2:44 pm

” And those requirements were largely dropped because of the efforts of well-intentioned pro-equality groups, who saw 20% down requirements as something that reduced the ability of the less well off to own homes.”

This is a lie, which has been refuted. See Krugman (try googling on his blog for ‘CRA’).

First off, the Bush administration did pursue loose money for a while, which drove down the dollar’s value. But I don’t see how a world awash in money looking for triple A rated bondlike things, and a country with people wanting to live in houses were going to stay apart from one another for long. Even if the local banks were separated from commercial banks, the loans would have been sold and bundled. If they had to hold on to the loans they originated, then the banks would have been unable to offer anywhere near enough mortgages, so other routes to origination would have been developed. If the US hadn’t enabled swaps, some other jurisdiction would have or some other trick was going to be developed. Worse case we would have seen special companies started to buy geographically diverse mortgages and hold them, issuing bonds and selling stock like any other company. So I don’t think regulation could have stopped the bubble.

But I don’t see how a world awash in money looking for triple A rated bondlike things, and a country with people wanting to live in houses were going to stay apart from one another for long.

Bingo. And if it had been, per impossibile, then we would be in the Lost Decade 2001-2011, unless you can come up with some other sector of the economy which would have provided the GDP contribution of the construction industry in those years.

@56 — Daniel, here I need education: Isn’t monetary policy up against zero interest rates anyway? Should central banks to start buying-up underwater mortgages? (Almost 30% of U.S. mortgages were still underwater in Nov.) What can monetary policy do now, to increase consumer demand?

2001-2011 *was* a lost decade. We just papered over it.

Companies pick their own accounting treatments all the time; accounting is not a rigorous application of hard and fast rules. And no accountant or regulator is going to object to a more conservative treatment.

This isn’t true. Accounting for interest income on an accruals (when earned) rather than cash basis is a pretty fundamental principle of bank accounting.

Sam, arguably true. The idea that it was advocates for poor people who were in any significant way responsible for those developments, however, needs some evidence to back it up. Got any?

Steve LaBonne,

The most extreme example of low-down payments was/is “down payment assistance”, which made it possible to get 100% LTV loans through the FHA. Here is a fairly typical petition from the 2007 attempt by HUD to disallow down payment assistance, and if you google for Barney Frank and down payment assistance you can see him arguing with his usual sharp wittiness against disallowing it.

#63: 2001-2011 was a lost decade. We just papered over it.

I completely agree. That’s the whole point, in my opinion.

As for bankers not being evil and / or regulation being ineffectual, I understand it this way:

1) The financial sector was not lobbying for “deregulation” in general, but rather focusing on specific loopholes and accounting definitions that would allow them to make highly leveraged bets on instruments that accounting conventions would rate as “riskless.” In industry terms I believe this is called maximizing the efficiency of capital. On the asset side, the goal is to minimize risk discounts and on the liabilities side the goal is to maximize off-balance sheet leverage.

2) The regulators were ultimately very accommodating of the above approach, meaning they seemed sanguine about the fact that the financial sector was, as a whole, focused on “maximizing the efficiency of capital” in way that directly exploited all available regulatory loopholes. (The other way to maximize the efficiency of capital, of course, is to make investments in risky projects… well the successful ones anyways.)

3) As a result, the entire industry became geared toward this approach to risk-taking — it was too easy. Essentially the game was to minimize accounting risk while taking on mounds and mounds of risk related to liquidity and off-balance sheet leverage. My assumption is that regulators knew this was happening.

4) Therefore, it seems to me that it would have been quite straightforward for regulators to raise the costs of this strategy, particularly by regulating leverage more tightly. The effect, in my opinion, would be to re-orient the sector towards taking on credit and market risk again (a direct consequence of reducing leverage would be to make many “riskless” trades unprofitable), and therefore creating momentum towards finding riskier but ultimately more productive investments (that is why they are risky). But they chose not to, and here is where I agree with the regulatory capture story.

We did indeed experience a lost decade but we didn’t have too. If the banks had lobbied instead for, to take one simplistic example, significantly better subsidies for renewable energy investments, we may well have had a very productive decade. If the regulators had restricted leverage, the banks may well have been compelled to do just that. Pick ARMs would have had NOTHING to do with any of this.

ISOK

The trouble is that it’s a synecdoche that is now driving policy agendas. Any attempt at expansionary monetary policy at the moment[1] is going to end up working through the banks (because they’re the monetary system), and it is going to end up creating profits for them (because monetary policy works through the price mechanism).

Maybe, but surely you wouldn’t say that no attempt at banking reform should be made because that would imply that banks have erred, to the prejudice of other policy decisions involving banks? Moral talk isn’t just a matter of identifying the bad guy for widespread condemnation. That’s not what’s in prospect here.

Banks lobbying to do business with poor people are lobbying on behalf of poor people. Poor person wants loan, bank wants to give a loan. Letting them come together helps them both. That’s why regulation was never going to prevent a housing bubble: many people wanted houses, and unless you were going to clamp down on all means for poor people to access capital there were lots of people going to give it to them. So while it might be nice to blame the people who lost money for the problems, someone used that money to have a house.

*It’s just occurred to me that that’s probably an anti-Scot slur.

OT but interesting: I don’t think it has anything to do with people from Scotland.

From Wikipedia/Wiktionary on scot:

Etymology

From Old Norse skot, later influenced by Old French escot (Modern écot), itself of Germanic origin. Compare shot.

Noun

scot (plural scots)

(UK, historical) A local tax, paid originally to the lord or ruler and later to a sheriff.

versus Scot:

A Scot is a member of an ethnic group indigenous to Scotland, derived from the Latin name of Irish raiders, the Scoti.

foreign trade and housing bubbles and deficits.
I simply don’t understand what the economists say, but if you carefully work thru the math, I don’t think there is a connection, or at least not a strong one
Lets say you buy a 10,000$ car from china; you have a car, and ABC company in china has 10k, which does them no good – they can’t pay their employees.
So ABC gives the money to a bank, and gets 10K worth of remembi from the bank.
the bank then has to find people in china willing to take $ and give remembi (after, all, the bank in china doesn’t want dollars either)
although it is strange to us, around the world lots of people like crisp franklins under the bed, so the bank does some of this
the bank also buys stuff in the us that chinese want – stocks, real estate, Tbills, etc
So, in the end
We loose 10K, and get a car
ABC corp gets 10K, and trades that for 10K worth of remimbi
the bank gets 10K, turns that into stuff (tbills)
the bank sells the stuff to people, and gets remimbi
the people are happy – they have given up some savings, and gotten tbills
So, you can see that the willingness of the Chinese to buy tbills directly allows the us govt to run huge deficits at low interest rates, because if the chinese didn’t buy the tbills, the gov’t would have to find some other buyer, and those people might demand a higher interest rate.
so , in that sense, the chinese were keeping interst rates down, which is a large part of the bubble.
To put it another way, it is exactly as if the chinese paid our credit card month – as if “they” went to Visa every month and paid off billions in debt.
Because we had all this extra money, we could spend more on houses.

However, that is not the whole story: the Federal Reserve, headed by A Greenspan, has the ability to raise interest rates any time it wants; Paul Volcker, now for some wierd reason a liberal hero, did this early in Reagan’s 1st term, and caused millions of Americans to loose their jobs (no academic economists lost jobs, so they thought Volcker was good)
I don’t know why Greenspan, abetted by both dems and repubs, didn’t raise rates; ask him.
But even with low rates, the bubble was , in large part, by lowering standards for loans.
Its really simple; your brother asks you for 100 bucks, hes good for it.
Some random guy on the street asks, you have doubts about seeing your money again.
It is the same for bankers: when they lend you 100,000+ bucks, untill around 1990, they were really, really, really careful; only (think its a wonderful life) upright, white, employed people were allowed to borrow.
Then, all of a asudden bankers started giving money to anyone, and for awhile they got away with it because they gave the loans to wall street, who simply lied aobut them and resold them

I make that, in order: one non-sequitur; one tautology with superfluous italics; one tautology without superfluous italics; one statement of the bleeding obvious, and one macho and rather sad* attempt at a heroic slogan.

(*It might be slightly less sad if there was a cat’s chance in hell of ‘an adult’ entering a rich man’s house in order to spit in his face, but of course there isn’t.)

@84:

Hardie, har, har…

Okay, so lemme have a go at laying out where I’m at.

I’m perfectly willing to accept the proposition that this crisis happens with or without actual corruption by individual bankers. That said, I think it reasonable to suggest that elites don’t go after white-collar crime nearly as hard as they go after working class crime. Still, while it’s worthwhile making sure those who committed crimes face justice, I don’t see much use in pointing too many fingers, given that if the Left makes it all about Bad People, all the government need do is prosecute them, and then close down any discussion of fundamental reform. Yes, what’s broken is the system – whether you define what’s broken as the neoliberal/managerial model, or capitalism itself more broadly.

But just because criminal acts weren’t the reason for this mess, doesn’t mean those individuals who kept clean bear no responsibility. I’m talking about incompetence.

Yes, it’s fine to examine this in terms of a structural issue and point to the balance of payments issue. But capital doesn’t flow by itself.

As I said month ago in a comment on Flying Rodent’s blog:

The job of someone working in the financial industry is to allocate capital correctly. They (the vast majority) failed.

Now, you could say, as dsquared has, that inflating the housing bubble was the only private sector led way out of the dotcom crash. That’s a plausible argument, but I’m mighty skeptical. It seems mighty convenient for one thing.

At worst, you’re suggesting that in 2001 there was literally no way for banks do their job without messing up. Which is a mighty fine argument against capitalism, I’ll give you that. No profitable, safe adventures to lend to for the past ten years at least sounds like a terrific reason for a more interventionist government.

But even granting this point, that doesn’t mean that banks still weren’t behaving irresponsibly by piling in on housing. By spiking the punchbowl, we all got badly hungover many more people lost their jobs and homes. Moreover, most (all?) of the gains of this last ten years went to the top (in this sense, the benefits accrued less like a simple “non-regulated drinking party”, and more like Girls Gone Wild). So the lost decade already happened. Plus, the US got out of that boom the ability to finance the $3 trillion Iraq war.

Or look at it from the perspective of shareholders. I doubt too many are particularly happy that their wealth was sacrificed in the name of short term profits by the people running the banks.

Yes, it’s true in many ways that the Bush Administration was an Epic Fail, and perhaps different policies at the start of the last decade would’ve seen a more sustainable boom. But many in the financial industry still failed to do their job. There’s enough blame to go around (direct link doesn’t seem to work – see Tim Wilkinson in that thread). As I went on, in that comment over at FR’s:

The job of economists is to understand the economy correctly. They failed.

The job of financial regulators is to prevent financial crises and bubbles. They failed.

The job of politicians is to look after the health of the economy. They failed.

The job of the media is to hold all of the above to account. They failed.

And:

None of those things is the job of the average Western citizen. Have the capitalists forgotten their Adam Smith (see your £20 note)? We have a division of labour in our society. This is why we aren’t all expected to be MDs. It is not the fault of the patient if the doctor fails to diagnose an obvious tumour. Sure, some people lied in order to get a loan and maybe this was a bit naughty (but before you rush to judge remember that we wouldn’t judge someone poorly if they stole a loaf of bread to feed their family), but that kind of thing should’ve been inconsequential in the grand scheme of things. It is only because the above groups failed abysmally in their duties that we had the clusterf**k of the last 3 years and counting.

It was one of the biggest financial crises in history. You don’t get that without an awful lot of human error. And trained professionals ought to be faulted for that.

Shorter me: Don’t reify capital flows.

So anyway, enough pointing fingers from me for now, let’s get the banking system right. I find it hard to believe such poor lending would’ve happened if the traders making the lending decisions had more at risk. The problem seems to be the disconnect between managers and shareholders. Simplest thing to do is to make the two groups one and the same. That is: require all banks to be partnerships or workers cooperatives (but then the latter is probably just the socialist in me talking), making sure liability is unlimited. Lending should be much more prudent.

Capitalism is fundamentally not a conservative beast. That’s not always a good thing.

Or indeed, Shorter me: do reify capital flows. They’re the most fundamental facts in international political economy.

It shouldn’t be underestimated, btw, that one of the actual effects of Fed policy was that it did in fact allow the Chinese communist party to administrate the transition to an industrial economy without major social stress or war, and this was certainly part of the policy calculus.

Neville, it’s almost like people make errors in thinking constantly. But why don’t we teach them how to be less wrong, instead of saying that’s how people think?

Anyway, I have real problems with the state creating a cozy den of cronies on Wall Street. If we are going to do that, why should we let the profits be taken by individuals?

That’s “some other Alex” speaking, by the way, but I agree with most of what he said, notably the point that housing bubbles are especially dangerous and evil thanks to the sheer numbers of people who can be involved and the size of the debt pile, and also to the generally ugly culture they promote.

Also that yes, corporate frauds should be prosecuted aggressively, but this is not a solution in itself, and a lot of people will think it is and be fooled by it into thinking everything is now OK, as with the Enron and WorldCom cases.

On reifying capital flows – there seems to be a great deal of variation in Europe on how the cheap money fed into household indebtedness (NL and DK) and housing bubbles (ES and IE, not DE or GR or IT), so how is the step from cheap money to unsustainable housing bubble inevitable? Doesn’t it need a failure of risk management in the banking sector to get totally out of control?

“And doubly so if the official policy of the central bank at the time is to create a housing market boom, and the official anti-bubble policy of the central bank is to allow the bubble to grow, on a promise that action will be taken to mitigate the consequences when it pops.”

But then can we say that, at least ex-post, the (keynesian) idea of the Fed to keep interest rates low in order to stimulate the economy was a bad one?

You do not seem to agree on this, even ex-post, when you say that we would have a lost a decade and that China would have had a much more difficult transition to an industrial society.

I do not know much about the second point. One could make the opposite argument, that is that if we end up stimulating the Chinese economy too much, then there will be a bust and social unrest will ensue.

But it is the first argument that I find most problematic. Maybe we would have instead grown more slowly but more stably. We would have added the houses we needed and not more than those. In general, one thing is to say that low interest rates may help us getting back to capacity when we are in a slump. Another thing is to say that low interest rates gives us higher long-term growth than we would have had. After all, at capacity we can only move along the frontier and producing more houses requires getting resources out of other sectors.

I am not saying that it is not possible to back up your “lost decade” claim but I argue that it is central to your argument and that it deserves more explanation.

The thing is that since this was a genuinely global crisis, I am nearly always going to be able to come up with a system that didn’t have the specific structural flaw that someone is fingering as the cause, but which still had a crisis.

This doesn’t license the conclusion that no specific structural changes should now be contemplated. Again, with the fire analogy: if the fire is big enough, even the buildings with sprinklers will get torched, but that doesn’t mean we wouldn’t have been better off with sprinklers everywhere.

The original argument for greed and self interest, say in Pierre Nicole’s late 17th-century version, was more prudential than noble. People like Nicolas Barbon clearly praised greed but there was debate between greed and self-interest as prophylactic and greed and self interest as good. The loud trumpeting of greed as good is of more recent vintage than the 18th century.

On China see, as one example of “stress,” Wukan:
http://www.nytimes.com/2011/12/15/world/asia/chinese-village-locked-in-rebellion-against-authorities.html

“It’s not original with me, but this is surely the most amazing financial collapse in the history of money: not a single criminal act, or even prosecutable civil violation, by a member of the ultra-wealthy financial elite. ”

My roommate was watching 60 Minutes about a week ago and they mentioned a statistic that scared me more than anything I’ve heard in quite a while: fraud prosecutions are at a 20 year low in the US.

Zoink??!?!?!?

I’m perfectly willing to believe that we would have had a nasty recession without fraud. But that fact that the fraud we know about isn’t being prosecuted (the robo-signing, the lying under oath re mortgage deeds, the entire Countrywide constellation of frauds) suggests to me that there is a systemic deference to the financial warlocks which isn’t healthy and which may have contributed to the severity of the recession.

Sebastian @108: there is a systemic deference to the financial warlocks which isn’t healthy and which may have contributed to the severity of the recession

Seems hard to quarrel with. Would dsquared agree?

I am not sure I buy the whole current account deficit / excess savings argument, in large part due to the work that is coming out of the BIS and related economists – eg. Tobias and Shin, Shin , Borio and Disyatat , etc.

In a nutshell, they argue that the focus on net flows that are measured in current account balances ignore the much larger increases in gross flows, which increased dramatically through the bubble era, particularly between European finance and the US to a much greater extent than any changes in the current account balance. Gross capital inflows to the US fell by 1.6 trillion in 2008, which vastly dwarfed the $20 billion drop in net inflows that shows up on the current account balance. The majority of these inflows and corresponding outflows were from the UK and Euro region, again dwarfing inflows and outflows from China and the oil-producing regions.

Also noteworthy is the fact that while the bulk of Asian capital inflows (especially China) were invested in US treasuries, which indirectly influence other long-term rates, a much larger percentage of direct MBS funding was coming from Europe. Shin argues that European banks were essentially intermediating 4-5 trillion in US funds, borrowing from MMDA and other wholesale funding sources and lending back through the shadow banking system.

I find it implausible that a massive increase in financing that vastly outstripped any real activity would not have an impact. Call it shadow-banking or finance rather than banking, if you prefer, but this massive financialization seems a more likely candidate for inflating the housing bubble than the much smaller current account imbalances (though it could be that net flows have a larger impact on marginal cost of credit than gross flows).

As for Golden West –isn’t that just Minsky? As financial bubbles build, it becomes increasingly hard for anyone to keep out of it as they become increasingly less competitive. Golden West could vet its loan applicants more carefully, but it would have a much harder time writing any mortgages at all if it refused to accept RE valuations (even non-fraudulent ones) because they were 30%-50% above the rent-equivalent valuation. Its choice in California was to accept “market” property valuations, or get out of the mortgage game entirely.

Getting major moral conclusions is certainly a lot easier if you help yourself to premises like “let’s ignore their claims of innocence!”

Ask yourself what we can learn from you, kidneystones.

77: Ah, thanks!

80: Relax a bit. The joke about the English–who are hardly an oppressed minority–was totally a joke. Also, knowing what expansionary monetary policy is a far cry from knowing who Charles Dickens is. My 11-yo knows the latter, for chrissake.