Americans see this as a crisis with small roots. Bad mortgages, or perhaps too much speculation in real estate. The changes have come so unexpectedly (to most American), so rapidly, that their significance remains a mystery. Leaders in the rest of the world see these events more clearly. Some examples were given in The most important news of the month. Perhaps the year. Here is another, extraordinary clear speaking for a senior government minister. I recommend listening closely.
“Interview with German Finance Minister Peer Steinbrück“, Der Spiegel, 29 September 2008 — Excerpt:
SPIEGEL: Mr. Steinbrück, Wall Street is imploding. The government of the United States wants to establish a $700 billion (€480 billion) bailout program for its banks and their bad loans. How serious is the situation for the rest of the world?
Steinbrück: We are experiencing the most severe financial crisis in decades, although one should be careful about historic comparisons with 1929. One thing is clear: After this crisis, the world will no longer be the same. The financial architecture will change globally.
SPIEGEL: Could you be more specific, please.
Steinbrück: There will be shifts in terms of the importance and status of New York and London as the two main financial centers. State-owned banks and funds, as well as commercial banks from Europe, China, Russia and the Arab world will close the gaps, creating new centers of power in the financial world.
SPIEGEL: In other words, we are experiencing the beginning of a tectonic shift…
Steinbrück:… but not one that is abrupt and jarring. It will be an evolutionary process that will take several years.
… SPIEGEL: And is the United States completely to blame?
Steinbrück: The source and focus of the problems are clearly in the United States. There are many causes. After 9/11, a great deal of cheap money was tossed into the market. Apparently some of that money went to people with poor creditworthiness. This led to the growth of the real estate bubble. The banks embarked on a race over profit margins. Then speculation spun completely out of control…
Update: another voice, same message
“A shattering moment in America’s fall from power”, John Grey, op-edi n The Guardian, 28 September 2008 — “The global financial crisis will see the US falter in the same way the Soviet Union did when the Berlin Wall came down. The era of American dominance is over.” Excerpt:
Outside the US, most people have long accepted that the development of new economies that goes with globalisation will undermine America’s central position in the world. They imagined that this would be a change in America’s comparative standing, taking place incrementally over several decades or generations. Today, that looks an increasingly unrealistic assumption.
Having created the conditions that produced history’s biggest bubble, America’s political leaders appear unable to grasp the magnitude of the dangers the country now faces. Mired in their rancorous culture wars and squabbling among themselves, they seem oblivious to the fact that American global leadership is fast ebbing away. A new world is coming into being almost unnoticed, where America is only one of several great powers, facing an uncertain future it can no longer shape.
What should we do?
That is a complex question. For a simple answer see A solution to our financial crisis.
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions in these.
Please share your comments by posting below. Please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
Some FM posts about the current crisis
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Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
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High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
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Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
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Another voice warning about the nationalization of AIG, 18 September 2008
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A vital but widely misunderstood aspect of our financial crisis, 18 September 2008
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A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
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Another step away from our Constitutional system, with applause, 19 September 2008
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What do we know about the financial crisis? What are the key questions?, 20 September 2008
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Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
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America appoints a Magister Populi to deal with the financial crisis, 21 September 2008
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Legal experts discuss if the Paulson Plan is legal, 21 September 2008
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Essential steps to surviving the current crisis, 23 September 2008
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How should we respond to the crisis?, 24 September 2008
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A solution to our financial crisis, 25 September 2008
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Is the US economy in good shape, or in terrible shape?, 27 September 2008
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A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
For a full listing see the FM reference page about the Financial crisis – what’s happening? how will this end?.
A few of the most important posts warning about this crisis
This crisis has long been forecast by many, including in articles on this site. Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results. To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime. Here are some of those posts.
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A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
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The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
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We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
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Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
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Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end? With re-balancing of the global economy, so that the US goods and services are again competitive. No more trade deficit, and we can pay out debts.
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- What will America look like after this recession?, 18 March 208 — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
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The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
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The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
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“The changing balance of global financial power”, by Brad Setser, 22 August 2008
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“The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008
The most recent press releases on the still-functioning website of Lehman Brothers say it all.
“Neuberger Berman to be Acquired by Bain Capital and Hellman & Friedman” Translation: Private equity firms rise in power and will now manage private investment accounts for ultra-high net worth investors. Less accountability, more exclusivity.
“Barclays Capital Opens for Business as Market Maker at NYSE” Translation: Foreign-domiciled banks will take leadership roles in our capital markets.
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Fabius Maximus replies: I have no opinion on the first theory, but strongly agree on the second. More specifically, Asian banks will be the winners from the current turmoil. Strong savings rates in their home nations, low leverage, low exposure to the losses in the EU and US … they might easily become the dominant financial institutions of the world.
That Spiegel article was quite interesting. As much as I would like to be proved wrong, my gut instinct however is that Minister Steinbrücks comments will have little impact on US law makers or elite US opinion.
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Fabius Maximus replies: Agreed. Nobody will take the other side of that bet!
Great link to Spiegel article, I agree that “Entire types of banks and their business models will disappear, but that doesn’t mean that anyone in Germany should be worried about their savings.” This is my view that the depression/crisis is mostly the rocket science finance over-securitization craze meltdown — that business model will die (or nearly). Too many Big Banks.
The German prime minister seems unaware of the gov’t role in pushing US banks to lend more to low income folk — that’s not the free market. I also don’t like Obama talking about ‘free market’ when Fannie Mae was in no way a free market creation. I have argued for clawback taxes on prior bonuses, long-term ‘windfall incompetence taxes’ — there should be extra pain for the Big Millionaire Bankers who supported this mess (most of whom are Paulson’s friends and dinner dates); so this is good:
“But the behavior of some elites is worth criticizing. We have to be careful not to allow enlightened capitalism to become tainted with questions of legitimacy, acceptance or credibility. This isn’t merely an issue of excessive salary developments in some areas. I’m talking about tax evasion and corruption.”
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FM replies: All of of these are irrelevances or outright fallacies. Individual bad boys were there, as they always are, but were insignificant compared to the systemic factors are work — as shown by the extent of the problem. Attributing this to “too many big banks” is absurdly without basis in fact or logic.
“The German prime minister seems unaware of the gov’t role in pushing US banks to lend more to low income folk”
You have mentioned this nonsense before in the FM comments. No more, please, unless you have evidence support it.
So far as I have seen, there is zero evidence that the Community Reinvestment Act (the only specific mentioned in these rumors), passed in 1977 played a significant role in the mortgage crisis. This is just right-wing propaganda. Matthew Yglesias gives the nickel summary on this:
For a more detailed rebuttal see…
(1)”Did Liberals Cause the Sub-Prime Crisis?“, Robert Gordon, American Prospect online, 7 April 2008 — “Conservatives blame the housing crisis on a 1977 law that helps-low income people get mortgages. It’s a useful story for them, but it isn’t true.” (Gordon is a senior fellow at the Center for American Progress)
(2) “No, Larry, CRA Didn’t Cause the Sub-Prime Mess“, Ellen Seidman, New American Foundation, 15 April 2008. Seidman headed the Office of Thrift Supervision from 1997 – 2001, and has long experience in this area (bio), and this article has links to additional evidence.
(3) “The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis“, Traiger & Hinckley, 7 January 2008 — “Indications that the CRA Deterred Irresponsible Lending in the 15 Most Populous U.S. Metropolitan Areas” (PDF, 21 pages).
Sarkozy also called for a complete overhaul of the global finance system, with global rules and oversight. This implies the end of certain types of free-wheeling capitalism, but it’s hard to believe that government technocrats/politicians will develop such a system free of the influence of major financial centers. The US Treasury was already planning to turn over the actual operation of its proposed “rescue” plan to a private financial firm, and the head of Pimco had volunteered to do it for free.
Further on Alfidi’s comment: I read this morning (The Big Picture, perhaps) that Lehman Bros collapsed when South Korea’s central bank decided against making LB a major loan.
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Fabius Maximus replies: That means nothing. Think of colored grains of sand dropping to form a pile. If the green grain hits and the pile collapses, was it a “green gain of sand” problem?
A footnote to our current discussion: The more complex and “multipolar” the banking system becomes, the easier it will be to shift funds back and forth. Hence: new opportunities to launder funds.
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Fabius Maximus replies: The current system is a network of nodes. The US dollar is the reserve currency, and the US the largest player. But in no sense is the US the center of the the network (like a star network).
Also, the post-crisis evolution is likely to involve much greater government regulation of investments and capital flows — perhaps up to and including capital controls (like the 1914 – 1970 world). That would make laundering money much more difficult (but it will still be done, probably just with higher costs and complexity).
Also, the post-crisis evolution is likely to involve much greater government regulation of investments and capital flows
Assuming you are correct, then we would anticipate invoice fraud to facilitate illicit capital flows combined with simple bribery to evade regulations. However, I would still assert that a multi-polar world would be more complex; hence more susceptible to money laundering through simple application of Murphy’s Law.
It was the CRA act signed into law in 1995 that is blamed for the crisis, not 1977. This author draws the conclusion that the bailout of the S&L crisis is a major reason for the recklessness of today: “Who’s behind the mortgage crisis?”, by Andrew Adams, Columnist for The Collande, student newspaper for Georgia State College, 7 March 2008.
It seems to me that down payments in the mortgage business have absolutely changed over the last twenty years. No money down mortgages from a bank or mortgage company were nearly unheard of twenty years ago. It is only in the last 10 years that no money down home mortgages became widespread in the U.S. To not see this as a dangerous practice is defying common sense. I don’t know if these mortgages are the fault of the government or not, but it seems like this almost certainly could have been regulated by the government, just as stock margins are regulated, and bank capital requirements.
This article from George Mason University with the obvious parallels between the mortgage meltdown of today and the stock market of 1929: “The Parallel with 1929 We Ignore at Our Peril“, Robert Brent Toplin (Professor of History at the U of NC), History News Network, 23 September 2008.
Here is an article from the government peddling zero down payments (paid for by the seller, which is totally useless): Statement of William B. Shear, Director of the GAO for Financial Markets and Community Investment: “”Seller-Funded Down-Payment Assistance Changes the Structure of the Purchase Transaction and Negatively Affects Loan Performance”
There are still signs up around here by builders that say you can live in their condo for one year for free. No mention as to what happens if there is no financing available after one year.
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Fabius Maximus replies: I am not sure what is the point of this comment, but in my opinion this is really weak. I will just mention a few points.
(1) I have not seen any analysis as to how the CRA played a significant role in causing the present crisis, just assertions. So I do not know the basis for your opening line.
(2) There was no “CRA act signed into law in 1995.” Perhaps you mean the regulatory changes ordered by President Clinton in 1993 which went into effect in 1995.
(3) Are you seriously offering an student newspaper column into evidence? Please don’t.
(4) The article by a history professor is mildly interesting. What is the relevance?
(5) “article from the government peddling zero down payments” —
The Director Shear’s statement does the exact opposite of what you alledge.
(a) He accurately states the problem (“higher delinquency and insurance claim rates than do similar loans without such assistance”), and
(b) makes appropriate recommendations (“Consistent with our recommendations, HUD recently issued a proposed rule that would prohibit the use of seller-funded down-payment assistance with FHA-insured loans”).
In your cited article, “Did Liberals Cause the Sub-Prime Crisis?” some progressives blamed Gramm’s desire for less regulation:
“…the Brookings Institution’s Robert Litan offered an opposing perspective. Litan suggested that the 1990s enhancement of CRA, which was achieved over Gramm’s fierce opposition, may have contributed to the current crisis. “If the CRA had not been so aggressively pushed,” Litan said, “it is conceivable things would not be quite as bad. People have to be honest about that.”
The Burning Down the House storyline:
Banks were under pressure to stop racial discrimination (see Obama’s 1993 suit against a bank for red-lining).
In 1995, there was additional enforcement acts against banks that did NOT make more low-income loans, BUT there was also the carrot of promising that Fannie Mae would buy such loans.
More high-risk loans were made, and the fees on such loans were quite profitable, and the risk on the loans was transferred to neo-gov’t Fannie Mae.
Such loans increased, but increased even more strongly by banks not subject to the CRA regulations.
Many Reps have long been a little or a lot against Fannie Mae’s gov’t risk neo-guarantee.
Pres. Bush tried to reduce the problem in 2003; Dems blocked it.
Sen. McCain tried to reduce the problem in 2005-2006; Dems blocked.
Barney Frank (D) repeatedly claimed Fannie Mae is fine thru 2006.
Obama supporters include former heads of Fannie Mae.
CRA pushed low-income loans; profits were assured thru Fannie Mae risk absorption — such CRA regulated profits led to unregulated copy cat loans, mostly also sold to Fannie Mae. This “blame CRA + especially Fannie Mae” story is not refuted by the articles.
Your second article, “No, Larry…”: “Second, CRA does not either encourage or condone bad lending. Bank regulators were decrying bad subprime lending before the turn of the millennium (see Interagency Guidance on Subprime Lending), and warning the CRA-covered institutions we regulated that badly underwritten subprime products that ignored consumer protections were not acceptable. Lenders not subject to CRA did not receive similar warnings.”
To the contrary: Fannie Mae’s acceptance of crappy loans shows that such loans WERE acceptable.
Similarly, “Did Liberals ” : “Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA — or any federal regulator. Law didn’t make them lend. The profit motive did.”
Such articles fail to note the need for Fannie Mae to take over the risk, nor its willingness to take over so many risky loans with so little scrutiny. The profit motive, WITHOUT FEAR of loss, is what made them lend. The Fannie Mae supporters allowed action without considering risk. “House prices will always go up”. The BIG LIE at the heart of what, some $2 trillion paper wealth now gone.
Question: how much house value paper-wealth will disappear from the peak in 2006?
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Fabius Maximus replies: OK, we’re done with this. These last two comments are enough of this nonsense. Story time is over. Please either cite sources for these assertions or move on to another subject.
These are actual studies, longer but with similar conclusions to the previous ones I have cited. They can be refuted, like any analytical work, but not by fairy tales.
* “Community Reinvestment Act: 25th Anniversary“, Harvard’s Joint Center For Housing Studies, 20 March 2002
* “Credit Where It Counts: Maintaining a Strong Community Reinvestment Act“, Brookings Institute, May 2005
Summary of these studies by Tim Westrich of the Center for American Progress (bio), 30 September 2008:
“Story time is over. Please either cite sources for these assertions or move on to another subject.”
You can read the following article: “The Long Road to Slack Lending Standards” Steven Malanga, Real Clear Markets, 1 October 2008. He cites as evidence “Closing the Gap. A guide to equal opportunity lending“, Richard F. Syron (Chief Executive), Federal Reserve Bank of Boston, 1998 — Foreword:
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Fabius Maximus replies: One way to test the validity of an theory is to examine the amount and kind of evidence offered in support of it. We see that here in the comments about the “CRA caused the credit crisis” theory. All we get to support this are assertions. Nothing even remotely like numbers suporting their case, and certainly no studies or reports — no analysis we can examine.
After many pointless comments, eventually we get one actual source: a ten-year old article by a Fed regional bank CEO in which he makes some typically mild recommendations (evident in the forward), which are taken out of context to show something or other. Note that the Fed did not have much regulatory authority (until recently) over mortgage lending or community banks — and none over the GSE’s. This paper does not provide regulatory guidance, but rather ideas for banks to consider.
Fab: “CRA caused the credit crisis” is actually more a shorthand for (my phrase): “gov’t supported loans to low-income workers so as to enable them to buy houses that they otherwise couldn’t afford caused the credit crisis”.
This gov’t support was greater in Fannie Mae’s acceptance of trashy loans than the much less significant CRA, but the Democrat pushed ideal of “affordable housing for low income workers”, no matter how they get it, is the key idea. Clinton’s 1995 changes increased the power of the ‘CRA rating’, even over non-fully CRA covered institutions (your own cited reference to wiki).
Your own comment#3 includes two other sources I cite, so your complaining about not citing sources seems a dodge against engaging in the real issues.
1) Were there gov’t actions to support low-income workers getting mortgages?
2) Was the default rate on mortgages of low-income workers a significant part of the mortgage crisis?
3) What is the exact relationship of the CRA to the low-income mortgages?
I think the facts indicate that CRA was far more responsible than non-CRA, like Countrywide. BUT, the same politicians pushing for CRA and pushing for low-income mortgages, were supporting Countrywide (and many getting below market rates on their own mortgages), and supporting Fannie Mae. Your insistence on separating ‘CRA, and only CRA’ from the aggregate ‘CRA and low-income mortgage interventions’ (with ‘CRA’ as a shorthand), is why you think the comments are pointless.
We’re talking about different things when using ‘CRA’. And if yours is more technically correct, mine is more generally relevant to mortgage meltdown, and the assigning of blame — which is particularly true when Obama keeps dishonestly claiming it’s the free market. Of course, your story is that the crisis is more than just mortgages, where I agree in the long and mid term.
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Fabius Maximus replies: I agree with your reformulated version of the storyline, But that is not how this fable is being spun by right-wing pundits.
I don’t see smoking-gun evidence that the CRA caused the bubble, but there is plenty to suggest that “CRA” in Tom Grey’s sense (supra) of “government-promoted lending to minority and low-income people” contributed significantly to the problem. The failing loans are concentrated in the sub-prime/option ARM/Alt-A sectors. Graphic and link.
The late Fed governor Gramlich stated in 2002 that such promoted lending was less profitable than mortgage lending as a whole. In 2004, he stated that the majority of such lending was done under the auspices of federal regulators, who presumably bore the expanding targets contained in legislation and administrative rules in mind. Links. What this leaves out is that the “mortgage community” went from reluctantly meeting promoted-lending targets circa 2000 to enthusiastically exceeding Clinton’s and then Bush’s rising targets by 2004-2006. CRA-style laws are not what changed marginally-profitable loans into gold mines.
It seems to me that two factors account for the change.
(1) Securitization — mostly via Fannie Mae and Freddie Mac — allowed originators to pass along loans to distant investors. In 1946, the Bailey Building and Loan Co. had to consider the risk of default over the life of a loan. In the new order, individual and institutional rewards were based on origination, packaging, rating, syndication, and reselling activities.
(2) Changed ethical standards in the mortgage industry. I presume that until the last decade, bankers commonly believed that it would be immoral to issue mortgages that put homebuyers at a substantial risk of foreclosure. 40% or so of single-family residence mortgages originated in California in the mid 2000’s were Option ARMs with interest-only payments for the first two to five years. Most of these were sub-prime or Alt-A, likely issued to people of limited means. It must have been evident at the time that many or most homeowners would be unable to afford the stepped-up payments that signalled the end of the honeymoon period. The assumption was that the real estate would be flipped or refinanced–a Ponzi scheme. Yet neither the industry nor its regulators displayed any ethical qualms about exposing customers to these risks.
The Milken Institute compiled an 84-slide deck of graphs on the mortgage crisis, here (PDF).
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Fabius Maximus replies: The picture is a bit different than you describe. The failing loans appeared first in the subprime seqment, then spread to Alt-A. Now default rates are rising rapidly in the prime mortgage segment — which was considered an almost-impossible event as late as last year.
It is not a subprime crisis, or a mortgage crisis. These were just the first links in the system to break from the rising stress.
Think of dropping grains of sand — each a different color — to form a pile. Eventually one will collapse the pile. But there was nothing special about that grain. The collapse is not a “green grain” problem. That’s the point of the graphs in “A picture of the post-WWII debt supercycle“.
The Director Shear’s statement does the exact opposite of what you alledge.
(a) He accurately states the problem (”higher delinquency and insurance claim rates than do similar loans without such assistance”), and
(b) makes appropriate recommendations (”Consistent with our recommendations, HUD recently issued a proposed rule that would prohibit the use of seller-funded down-payment assistance with FHA-insured loans”).
The wheels of HUD turn very slowly. These changes did not start until 2007: “MORTGAGES; HUD Tightens the Rules“, NY Times, 14 October 2007. There were exceptions to this which were closed just this month (Oct 2008): FHA Downpayment Grants for Homebuyers. So my point raised by HUD was a real problem until very recently.
The issue here is low and no down payments for houses. This parallels the 1920’s US stock market with low margins and ever increasing stock prices.
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Fabius Maximus replies: Not only have I seen nothing remotely like a study or analysis to support these allegations, but the crisis has moved far beyond mortgages. As I explain in the next comment, the early stages are now of interest only to historians. The global and multi-asset nature of the crisis shows that attributing this crisis to minor rule changes is absurd.
FM: “It is not a subprime crisis, or a mortgage crisis. These were just the first links in the system to break from the rising stress. Think of dropping grains of sand — each a different color — to form a pile. Eventually one will collapse the pile. But there was nothing special about that grain. The collapse is not a “green grain” problem.”
The grain of sand analogy is a poor model. As for the first line, how is it not a subprime or mortgage crisis if they were (by your admission) the first links in the system to break down? When a link breaks, your chain is useless. It’s as if you’re saying that the match struck by the arsonist was just the start of the fire, not the cause.
Actually, perhaps the sand analogy could work, but you’d have to look at who was allowing the sand to drop, and continue to drop. That would seem to me to be those who supported ideas of social engineered mortgage lending.
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Fabius Maximus replies: I did not say link in a chain, when breaking one link makes it useless, but “links in a system.” Like a network, in which breaking one link weakens the network, but it still works.
The system is experiencing torque, and the weak lins are breaking — one by one. The order in which they break has some minor significance, but that’s all. Obsessing on the early links to break just renders one’s analysis ilrelevant as the process continues. It has moved beyond just mortgages, beyond just consumer debt. Large companies, large States (e.g., California and Mass), entire nations (e.g. Iceland and Ukraine) are experiencing severe troubles.