The dangerous myth still believed about the Lehman Brothers bust
washingtonpost.com
washingtonpost.com
Related myth is the idea that nobody saw it coming. I went to a luncheon at Goldman's in 2006 where they announced things would start looking rocky in 2007 and the big whammy would be 2008.
Greenspan supported the repeal of Glass-Steagall, and also supported the Commodities Futures Modernization Act, which did a huge amount to legitimise Credit Default Swaps.
He opposed HOEPA oversight by the Fed of fraudulent liar's loans by unregulated lenders. He was on the wrong side of multiple conflicts of interest, including some related to Enron's SPV frauds.
While Greenspan was giving PR-scented talks about the renewal of trust in the markets after the regrettable failures of the Enron years, the FBI was warning there was an epidemic of mortgage fraud.
So - no. Greenspan was not a misunderstood and essentially powerless economic moralist. He was at ground zero of the crash, and deserves a significant share of the blame for it.
We are in a debt fueled rally that will crash and we might be out of ammo to keep the system going.
Without the influence of competitive forces, the Fed will remain.
When competitive forces necessitated 'survival of the fittest,' congress took over control of the money supply. This was demanded of the US government during the Civil War when there was an actual threat of: 'we will die if we don't act in the best interests of The Union.'
Perhaps the only thing more exasperating than the Fed's transfer of wealth from money holders to the Wall St economy (and minimally, the US govt) is the weasly arguments used to justify it: "Creating 4 trillion dollars and helicoptering it to Wall St is fine because inflation didn't rise, so therefore the money was free thanks to our clever understanding of economics." In other words, due to magic, the Fed creates value out of thin air... Oh but they can only share it with Wall St because otherwise they will crash the US economy.
But Greenspan clearly stated that he believed that laissez-faire capitalism was the optimal option for democratic society even when it causes some Irrational exuberance.
Greenspan was Objectivist who had close relationship with Ayn Rand until her death. Allowing market irrationality to select who wins and loses was not against his political ideals. He believed that better are people being taken advantage by the masses in democratic society.
Greenspan politicized his office and always advocated laissez-faire. He was acting very rationally based on his ideology.
Likewise, Greenspan while at the Fed may have occasionally mouthed vaguely Objectivist sentiments that echoed his earlier association with Rand, but he was, after all, head of a quasigovernmental body that creates money out of thin air. By this point in his life, Greenspan’s ideology was living it up as a member of the D.C. elite.
To see him advocating laissez-faire, read his essay “Gold and Economic Freedom”[0] — that comes off nothing like Chairman Greenspan.
At least objectivists had the idea that laissez-faire benefits the few "the new elite", those who deserve and did not have the weird idea that laissez-faire lifts all up.
I’m no Objectivist, so what do you mean by “the weird idea that laissez-fairy lifts all up”?
[1] https://en.wikipedia.org/wiki/All_Watched_Over_by_Machines_o...
In its diagnosis of impotent regulation encouraged by corrupt and feckless legislators serving their donors, it is factual.
Back in 2004-2006, anybody who wanted to see what was coming would see it. I was renting a small house in a high end community (Newton MA) in that era. A neighbor who owned her little house next door (3br, 1.5 baths) said she was going to put in on the market for 1.2M. We agreed that she better sell it quickly, while the mortgage bubble was still expanding, if she wanted that kind of money for it.
Neither of us are economists or lawyers. People with access to lots of information could surely see the problems, if they hadn't had their heads in, well, the dark.
Now that 12-14 years have passed, incomes - and inflation - have risen and those same prices appear more reasonable. Accounting solely for inflation, $1.2 million today was worth $970,300 in 2006 and $901,900 in 2004.
I lived in a similarly-priced neighborhood less than 30 minutes away during that time period. Houses continued to sell normally throughout, though sometimes they were on the market a little longer than they would’ve been previously. Prices continued to go up.
I’m just a random guy on the Internet. Maybe you’ll believe WaPo[0].
But why let facts get in the way of a good screenplay?
Facts such as that Bear Stearns, Lehman Brothers and Merrill Lynch — three institutions at the heart of the crisis — were pure investment banks that had never crossed the old line into commercial banking. The same goes for Goldman Sachs …
The infamous AIG? An insurance firm. New Century Financial? A real estate investment trust. No Glass-Steagall there.
Two of the biggest banks that went under, Wachovia and Washington Mutual, got into trouble the old-fashioned way – largely by making risky loans to homeowners. Bank of America nearly met the same fate, not because it had bought an investment bank but because it had bought Countrywide Financial, a vanilla-variety mortgage lender.
[0]: https://www.washingtonpost.com/lets-shatter-the-myth-on-glas...
And one of the tactics to help stop the crisis was to allow remaing investment banks to convert to bank holding companies that accept deposits--which would have also violated Glass-Steagall.
And that Europe didn't have a regulation like Glass-Steagall, yet the crisis didn't start in Europe, it started in the U.S.
[1] https://en.wikipedia.org/wiki/Glass-Steagall_legislation
The article continues: "The Greenspan Fed also tried to force more capital into the banks it supervised, but it soon realized that this would drive risk-taking into various “shadow banks” that lay outside its authority [...]"
Funny how the "if we regulate it, it will just move underground, so we might as well allow it" line is applied to financial misdeeds and guns (in the US), but not to prostitution or drugs (at least in the past).
Fully agreed that Ayn-Rand-acolyte Greenspan bears some responsibility for the meltdown. Maybe the author of this article (and his biographer) got too close to his subject.
However, the core lesson from the article rings true: The problem was not that people didn't know. It was that they either did not want to or did not manage to do something about it, because many forces conspired to keep the status quo.
The language used to talk about economics is so technical that any talk about what is or isn't still believed is practically unknowable. I'd accept that there is a consensus on "it is obvious what the problem was when Lehman went bust", and simultaneously that there is no consensus on "what was the problem was when Lehman went bust".
This article talks in general and specific terms about the regulatory framework. Seems reasonable. But in this age of fractured politics (where no blow is too low) an opinion piece is either preaching to the choir or being completely ignored.
Macroeconomics has a major theme - how to divide the economic pie up in a manner that encourages people to contribute to said pie. I'd rather know who is still talking seriously about the growing and contributing part of that theme and whether they are currently in charge or currently not in charge of the financial system.
Modern economic management is really focused around debt (c.f. how the money supply is enlarged and how quickly that happens in the US). After 2008, it isn't obvious whether the debt-based approach is growing the pie as there seem to be a real indicators that are not promising. I suspect that debt is simply moving pieces of the pie around. But intead of establishing these broad and general strokes of the picture people do love to dive into the detail of regulation where they are going to make mistakes, be wrong and get defensive about points that ultimately do not matter.
Nor is the balance sheet of central banks. Inflation is low despite huge QE programs.
The problem is that there is no countercyclical program to save for the eventual downturn. (Important note, there never really was. Centuries ago villages disappeared, cities emptied out, thousands died from starvation, crime was worse, and armed conflict coming to town was very much always a possibility). Sure there are social support systems in many countires. The US has a very inefficient one, it doesn't really help getting out of the gutter.
It may not be the problem but it is a good stating point. The degree of indebtedness is important.
> Inflation is low despite huge QE programs.
My understanding is that inflation is measured as a consumer-goods-only effect and that the QE programs gave vast sums of money to people who used it to buy assets (kind of a tautology that, because obviously it didn't end up flowing into consumer goods).
The fact that it didn't show up in the inflation statistics is a good start, but why is that the only way it can cause problems? It looks like the government picking winners and losers, and governments have a terrible track record of making those decisions.
I think what you mean is the ability to service the debt under a variety of non "act of god" scenarios.
There are a lot of companies around the world defaulting on USD denominated debt now because of rising interest rates, that at ZLB, would have been able to keep racking up the debt because it would have still been serviceable.
Same is true for a lot of governments with a decent amount of USD denominated debt that are finding it hard to service because of currency outflows from domestic financial (debt/stock) markets in response to rising interest rates (combined with a lack of sufficiently acceptable local options).
>It looks like the government picking winners and losers, and governments have a terrible track record of making those decisions.
It definitely seems like this to me, and is more pronounced/easier to see in places where the state has a heavier influence on the markets. But even this will only last so long before it doesn't.
I thought at this stage everybody knew that already.
Yes, we get it. Mortgage credit was too easy to come by in the 2000s. That availability was driven by government subsidized lending. But that bubble should've burst and triggered a recession that was perhaps a bit worse than ordinary. It left a crater in the global economy because the financial products it tourched off happened to connect every major financial institution in a way I don't think anyone understood until the autopsies of the Great Recession started to come in.
https://www.cbsnews.com/news/loans-to-low-income-households-...
To me it doesn't matter who built or lit the fuse. The piles of interconnecting ordinance were the derivatives. Any asset in a bubble that had decent exposure in a derivatives market could've triggered the disaster. The layers of deals too complex for anyone to understand that entwined many major financial firms are what made the Great Recession "Great".
I figure this stuff is being dredged up because of the 10 year anniversary of 2008. The whole world is going to change by April next year, I think the US economy might be chugging along even in spite of the hell everyone else is about to endure in their markets because Trumps tax cut is basically a multi-trillion dollar cash stimulus in the economy that goes broadly to nearly everyone.
I made a couple observations: The fed is now afraid to show its cards. No longer will it give forward guidance because they are not actually sure what they need to do. If they raise rates they risk collapsing prices on debt instruments, if they lower rates they fear inflation. As for protecting the currency, they don't need to do that. The dollar is already a policy nightmare for most of the world as to its current value. Inflation isn't bad at all either. Employment is as good as it gets I think. So why raise rates? But this is their plan. They plan to raise rates all the way to 2020 (familiar year reported) and then... what? Also, I've been seeing ads for adjustable rate mortgages at very low rates. Are they going to reset everyone's mortgage in 2019 causing a huge downwind pressure on home prices? That seems to be the 2006 2007 2008 pattern all over again.
a) Believe that a free market can police itself; or
b) Be so myopically hell-bent on the bottom lines of their interest groups that they're willing to recklessly sabotage important regulatory impediments to meet their ends.
Either way, a lot of powerful people could still probably stand to be admonished on the importance of well-enforced regulations, even if those admonitions are embarrassingly basic. Am I missing something here?
Also, whether or not the economists believed in the efficient market hypothesis at the time, the conservatives and libertarians sure did, and they continue to do so.
People let the economists use word-salad to confuse and obfuscate matters, and this article is just naive whitewashing that does no root cause analysis and ignores the rca that has already been done.
when speaking about the financial system, I am often reminded of Ralph Waldo Emerson, "For a thousand hacking at the branches of evil, only one is striking at the root."
At one time it was considered an iron clad rule that Americans would always pay their mortgage. But something changed in the American character and suddenly millions of Americans were fine with defaulting on their debts.
There's plenty of blame to go around, but this recent turn to populism in the wake of the financial crisis is particularly ugly for its rank hypocrisy.
That narrative should be licensed to Disney as a fairy tale.
> 70 percent of defaulted loans had blatant misrepresentations on their mortgage applications. The FBI estimates that mortgage fraud (by borrowers) increased 1,000 percent from 2001 to 2007.
And they defaulted strategically to make money:
> They also discovered these sorts of events—the abandonment of a mortgage obligation to pay when people were perfectly able to pay—represented fully 20 to 30 percent of the delinquencies that took place in 2007 and 2008
The illusion that the American business community deserves moral consideration has been used to fleece the general public for years.
In the mid 2000s, mortgage lenders were working with the customers, agents at countrywide for example, were helping their customers fill out documents fraudulently. (Years later a few would go to prison for this.) This was not a failure at the bottom, the system allowed those who would attempt to commit fraud, commit said fraud because they profited from it.
Or are you completely unwilling to believe that complex, and opaque systems need any kind of regulation to prevent abuse by people at all levels. And that people at the bottom of the system are the most likely to be abused by said system.
How is the normal not finance expert person supposed to navigate this? On the one hand you are supposed to believe investment advice but on the other hand you are not supposed to believe the financing advice you get when buying a house.
The financial industry wants it both ways. We have to trust them as experts when it suits them but when things go wrong it's the customer's fault.
It is pointless to say "they should have known better" because lots of people simply did not, and this had bad consequences for many who did, including people who did act responsibly, but lost their homes anyway as a consequence of this recklessness.
It is more to the point to say that the institutions and regulators should have known better.
One reason this part of the story is being overlooked is that none of the executives responsible for encouraging and facilitating irresponsible and even fraudulent lending were sanctioned in any way (maybe they had a reduced bonus one year, and had the effrontery to claim that was unfair.)
Ironically, those who walked away from mortgages they could have paid were acting as rational economic agents.
Losing a home thrusts one either out into the street or onto the mercy of families because the financial ruination may make it somewhere between difficult to impossible to rent even if one has the money. It ruins your credit, breaks up families, ruins relationships, hurts ones job prospects even.
The idea that people faced ruin because they didn't have the character to live up to their obligations is more than offensive.
When I lost mine after weathering a number of crisis the bank wasn't interested in anything less than all back money due immediately or nothing so catching up was impossible. Hell there was even a government program to help people stay in their homes that would have lent every bit of the money required to catch up and the bank wasn't interested.
In brief shove your crisis of responsibility because you have no earthly idea what peoples lives are like or the shit they have had to slog through.
This is a gross sociological question involving millions of people. Nothing anyone can say about a question like this can possibly cover every case.
Maybe Bahnsen is wrong, but he's not uninformed. He works in the financial industry and makes an interesting argument.
Banks are supposed to be experts in assessing risk and financial products. If an expert sells a bunch of bad loans knowing he is going to fraudulently sell them on to others anyway its the experts fault for tanking the economy.
At worst the buyers are stupid. There certainly was no crisis of faith and values.
I think a lot of people have learned that you should do whatever you can get away with because otherwise you are a sucker.
The reason people decided to start defaulting on their debts is similar to the reason people sell stocks at the bottom of the market. They wanted to get rich quick and saw the chance disappear, so they ditched the mortgage they could barely pay. They took out a huge loan they could barely afford in the hopes of selling in two years when they could do it capital gains free and seeing a big profit. The price to rent ratio was very high. These people were trying to ride a wave and got caught out by the tide. I mean, if you have a mortgage it doesn't matter at all if the price of the house you are living in falls. The only reason to cut and run is because you want to cut your losses on a failed investment and your dreams of getting rich quick.
The fix has been pretty simple- lending standards have been greatly tightened, making it harder for people to buy houses they can't afford or for those with bad credit to get mortgages. It notably didn't take any major changes to derivatives marketing (because the sophisticated buyers of those products had already learned the lesson). The only change needed to normalize the market was to prevent the retail buyer from taking on too much debt. This seems indicative as to what was a fundamental cause of the problem. It runs counter to some of the incentive programs intended to increase home ownership.
I don't have that much insight in the technical details of mortgages in the US but at least in Sweden, if the price of your house falls too much, the bank will send you a (huge) bill for you to cover their risk. E.g. if you buy a house for $300000 and borrow $225000, then if the expected market price of your house would fall to $200000, the bank will simply send you a $25000 bill.
Amusingly, such morality fables often get pushed by business leaders who understand the concept of strategic default perfectly well in their own dealings. You don't see former Lehmann executives working night shifts at McDonalds to make THEIR creditors whole.