Words of wisdom

by on January 23, 2010 at 9:36 pm in Economics | Permalink

You could construct a whole blog of mishnah on Scott Sumner, but no, I cannot link to every post he writes.  Nonetheless I especially liked this passage:

If our banking system absorbs trillions in losses you can be sure the government will step in, regardless of whether we have big banks or small banks.  And if our banking system isn’t in crisis, then FDIC is perfectly capable of handling an isolated bankruptcy, even at a large bank.  In any case, I can’t imagine a future where the US doesn’t have any large banks, but Europe, China, Japan and Canada have lots of large banks.  Can you?  Wouldn’t it make more sense to try to prevent the banking system from suffering trillions in losses after a bubble bursts, perhaps by requiring sizable downpayments?

But then I read that the FHA is about to set much tougher standards for FHA mortgages–they plan to require borrowers with a 590 credit score to put down at least 3.5% downpayments.  As Tyler Cowen recently argued, you knew Congress wasn’t serious about global warming when they refused to make Americans pay more for gasoline.  And I would add that you can be sure that the populists who want to “re-regulate the banking system” aren’t serious when all they can do is talk about 3.5% downpayments for bad credit risks.  It is so much more fun to bash big banks.

Bill January 23, 2010 at 10:23 pm

Responding to the comment:

” In any case, I can’t imagine a future where the US doesn’t have any large banks, but Europe, China, Japan and Canada have lots of large banks.”

You don’t have to be a big bank to do big things.

Back when investment banks were partnerships, they formed syndications–joint ventures, if you will–to underwrite risk.

Now, it doesn’t bother me if banks get bigger, so long as they are not leveraged. If you do not believe in regulation–to control or monitor excessive leverage–then I guess you go for size limits and work with joint ventures.

But, what will probably happen is that everyone will say we need larger banks, Congress will take a recess, and the wheel will turn again, and again, and…

My preference is that if the FDIC continues to subsidize larger banks acquiring smaller banks, that they consider joint ventures of smaller banks acquiring a failed larger bank. We should be able to have unbiased growth and diminishment in the competitive system without subsidizing risk or the growth of behemoth into leviathon.

Milton Recht January 23, 2010 at 10:52 pm

The 1980s S&L crisis was about $125 billion of losses (about $250-300 billion today) and the government stepped in and most of them were small banks by comparison to banks then or now.

In 1984, the US took over Continental Illinois Bank and its total assets were around $40 billion (about $86 billion today).

Sumner’s trillions is way too generous. The government will step in at a much lower level of losses if there is public awareness and anxiety, or overreaction by the regulators.

ahappinessexperiment January 24, 2010 at 12:54 am

It bothers me a little that someone who argues passionately against the usefulness of the term “bubble” still uses the term bubble to get his point across.

Andrew January 24, 2010 at 5:55 am

Crazy thoughts: It’s pretty remarkable that as many people pay back their loans as do. I’m wondering if the housing bubble will come out to about the amount correlating to what the total value of traditional 20% downpayments would have been.

I’m wondering if our insistence that everyone has strong willingness to repay unless something outside their control happens indeed pushed the interest rates toward the long end, steepening the yield curve and thus increasing the profits for borrowing short and lending long, until the music stopped.

It seems we haven’t really learned much since the depression, but we do have better technology. Every bank could have a living will. When it dies, you hit a button and all the deposits move to its heir.

E. Barandiaran January 24, 2010 at 6:23 am

Nice example of double/mutual cross subsidization.

Ralph January 24, 2010 at 9:07 am

“And if our banking system isn’t in crisis, then FDIC is perfectly capable of handling an isolated bankruptcy, even at a large bank”

His argument hinges upon this statement. To the best of my knowledge, no one has ever gone through BK proceedings with a bank as large as Citi or BoA that also has significant international exposure. In 2008, that would have meant doing this with multiple banks of that size.

Scott Sumner January 24, 2010 at 3:21 pm

Boonton, The point is not to prevent bubbles, or “bubbles” (since as one commenter pointed out I don’t believe in them.) The stock market “bubble” didn’t almost bring down our banking system. Why not? Because of those 50% margin requirements you referred to.

ziel January 24, 2010 at 6:41 pm

Larger down payments may tamper a bubble slightly…

There would have been no housing bubble and hence no collapse had 20% down, 28/36% DTI been in force over the last 10 years.

Boonton January 24, 2010 at 6:55 pm

Lindsey

The housing bubble got going because the government used the CRA to strong-arm the banks into issuing mortgages to unqualified borrowers. If the government had not pushed the banking industry into this, there would never have been any sub-prime lending and the like.

BullS****. Subprime loans by definition did not meet the criteria for Fannie/Freddi Mae to buy them. Likewise Fannie Mae and other GSE’s were losing marketshare. Banks weren’t being forced to make bad loans, banks were trying to grab as much of the ‘bad loan’ business as they could. As house prices rose gov’t entities started to loose share because they are not allowed to partisipate in loans for expensive houses. During the boom banks bragged at how great a job they were doing expanding minority and low income lending. This wasn’t because the CRE was ‘strong arming’ them…it was because they thought the market had created a new and wonderful innovation that could help the poor better than gov’t programs while making the banks lots of money. All the speeches and statements that are now being mined to support a ‘CRE forced the banks to make bad loans’ thesis were made, at the time, with the idea that the market had finally solved a problem for the low income and it was time to celebrate.

Konstantin January 25, 2010 at 3:57 am

“And if our banking system isn’t in crisis, then FDIC is perfectly capable of handling an isolated bankruptcy, even at a large bank. … Wouldn’t it make more sense to try to prevent the banking system from suffering trillions in losses after a bubble bursts, perhaps by requiring sizable downpayments?”

.. perhaps by aligning insentives for the banks right in the first place?
Sumner misses the point. TBTF is all about insentives, not about systemic crises aftermath. When you are TBTF, you WILL take excessive risk, ceteris paribus.

The real a January 25, 2010 at 5:17 am

“20% down might be demanded for gov’t backed mortgages but would you have demanded that private mortgages never be for more than 80% loan to value? ”

Yes. That is, any bank who made a loan with less than 20% down, would have had to carry higher reserves for the difference. In fact, once housing prices started to go up over their historic average, banks should have been required to have all house loans with deposits superior to 20% or to carry reserves for the difference. (Reserves for second lien loans should have been at 100%, etc.)

The real a January 25, 2010 at 9:34 am

Ah, but I wouldn’t allow securitization, either.

Simon Kinahan January 25, 2010 at 4:30 pm

Why not allow for securitization? It dates back to the 1980s and the secondary market for whole loans, which has the same principal-agent problem, dates back to the 1950s, so its not exactly at the forefront of financial “innovation”. The problem wasn’t securitization, it was that investors were prepared to ignore the underlying credit quality when pricing the bonds. Had the market been better structured to make the credit quality clear (as the market for GSE MBS is) this would not have happened.

The advantages of the secondary market are huge – I doubt you’d be able to get a 30 yr fixed rate mortgage at a decent rate if it didn’t exist. Far too few institutions have the resources to absorb the interest rate and credit risk for such a long term.

The real a January 26, 2010 at 4:53 am

“Sounds like you’re on board for neutering the finance industry….”

More like trying to ensure the finance industry doesn’t go haywire again.

“Why not allow for securitization?”

If you could, for instance, ensure that such securities could not make their way into the Mom-and-Pop banking/savings system, then I would be be okay for securitization. But I don’t see how to do this. E.g. allowing only hedge funds to buy them still means the securities could contaminate the banking system because banks are their prime brokers. I don’t see just how you could make the walls high enough. And, of course, if you could make them high enough, the demand for said securitization would be much lower than it was, so I’m not sure what the point was.

“Had the market been better structured to make the credit quality clear (as the market for GSE MBS is) this would not have happened.”

The GSE market was corrupted by the implicit federal guarantee.

“Putting less than 20% down goes back before the 1980’s so why trash that?”

Maybe to have a sound banking system?

6ave coupon code February 26, 2010 at 6:51 am

Good inspiring post!Well i was passing by here searching some information and came across your post.Its really very nice.So i will look forward for more information.

Comments on this entry are closed.

Previous post:

Next post: