His new paper is now on-line. He summarizes his argument as follows:
1. It isn't "too big to fail" that's the problem, it's the rescue of creditors going back to 1984, encouraged imprudent lending and allowed large financial institutions to become highly leveraged.
2. Shareholder losses do not reduce the problem even when shareholders are the executives making the decisions
3. These incentives allowed execs to justify and fund enormous bonuses until they blew up their firms. Whether they planned on that or not doesn't matter. The incentives remain as long as creditors get bailed out.
4. Changes in regulations encouraged risk-taking by artificially encouraging the attractiveness of AAA-rated securities.
5. Changes in US housing policy helped inflate the housing bubble, particularly the expansion of Fannie and Freddie into low downpayment loans.
6. The increased demand for housing resulting from Fanne and Freddie's expansion pushed up the price of housing and helped make subprime attractive to banks. But the ultimate driver of destruction was leverage. Either lenders were irrationally exuberant or were lulled into that exuberance by the persistent rescues of the previous three decades.
The full paper is here. Arnold Kling offers comment.
During the housing bubble the GMU mafia almost to a man claimed that the high home prices demonstrate3d that we were really a lot wealthier than the government data showed and that there was no problem with high home prices.
Now the GMU mafia is using these economic developments they approved of at the time to blame the government agencies for doing what they thought was a great idea at the time.
Talk about the pot calling the kettle black.
I would add the trading in securities for which there were no liquid markets and insufficient reserves.
Plus an old fashion bank run, perhaps made worse by increasing uncertainty about political changes, regulatory confusion, etc
Well, well, well. Finally agreement on the point that incentives to management do matter.
Andrew
Has a true free market ever functioned successfully for any reasonable length of time? Did Adam Smith believe in an absolutely free market? Considering the global nature of the 21st century market, what is the most likely outcome of removing all regulations and allowing man to pursue his dreams of wealth unfettered?
This is TC explaining that he top-ticked the market.
http://www.marginalrevolution.com/marginalrevolution/2005/04/do_we_live_in_a.html
I’m curious, was any individual economist who was “right” – were they able to demonstrate that in any way other than by gut feeling?
libert,
Relevant page numbers?
EXPLICITLY Hayekian economists were the FIRST to identify the pathologies here — see for example the papers of BIS chief economist William White dating back to 2003, when White personally first confronted Alan Greenspan …
Andrew, I am looking for the Marginal Revolution post which linked to a Cato sponsored piece that said managerial financial incentives didn’t have anything to do with the meltdown. It was da gov’ment.
Andrew, By the way, the reason I remember the post so well was that it was at the time Dodd was trying to limited bonuses to executives that received Tarp money. The argument was this was unreasonable, because the managerial bonuses and compensation structure had nothing to do with the problem.
If you stand still, the earth will move around you.
Yes, government policy played a role in the bubble.
The low interest rates were a necessary, but not a sufficient condition to create the bubble.
But Fanny and Freddy were late to the game and played a much smaller role in the process than the right would like to admit. The real financiers of the housing bubble was the shadow banking system that the private sector built. But by emphasizing Fannie and Freddy and neglecting the role of the shadow baking system this analysis appears to be just another excuse to blame government for everything and advance your belief that the private sector can do no wrong.
The real issue that is being neglected is that bubbles appear to be inherent to financial market capitalism. Often it can be argued that bubbles and bust may actually be a good thing in that they create the physical capital that create our rising standards of living even if the original investors all are wiped out as usually happens. See the great paper on the British railroad bubbles of 1840 that was reverenced here a few weeks ago or that we are even having this discussion at all because of the tech bubble of the 1990s. I for one actually agree with Greenspan that we are probably better off to let bubbles run their course and just have monetary policy try to minimize the damage when the bubble burst.
What was different about this bubble is that building a mass of MacMansions did little or nothing to advance our standard of living
or make us better off. But government policy has favored housing since the depression and I completely fail to understand what the government did different in the 2000s that would have made that much difference.
Mommsen:
Pages 30-33ish, although it’s part of a broader argument, which probably merits reading to get the context. However, you could probably skip the first half, start at page 30 and be fine. Friedman elaborates more precisely on this topic in another paper, but for the life of me I can’t remember the title.
Bill, that’s fine, but one Cato piece, whatever it said doesn’t constitute monolithic agreement among libertarians.
Nor does Russ Roberts, AFAIK, represent the entire GMU. Nor does GMU (or Cato) always represent me. I’ll help spencer out. I’ll assume he is talking about (1) the lack of home values showing up in inflation figures and (2) the lack of home values showing up in government savings data.
Yes, both of those things are still ridiculous. In fact, (1) was a big cause of why The Fed was fooled. And, lo and behold, The Fed has re-affirmed the position that they aren’t going to incorporate housing prices.
The UK’s a small island with highly restrictive planning laws and a strong tradition of home ownership. Add easy money and no generational memory of a housing crash and that’s all we needed.
James Taylor — mortgage fraud was a real problem. A mortgage fraud scheme put prostitutes and swatters on my block in an Orange County boom development. And note well. The FBI essentially shut down operations working on this stuff in the early 2000s.
Greg has it exactly right. Fraud was rampant. It is my sense that Chris Sweeker’s complaints were what caused the FBI to shut down fraud investigations.
And both Greg and I live in the Mortgage Fraud Capitol of the world, Orange County.
When the fraudulent loan origination business shut down, a couple of those scammers morphed into a loan modification fraud and moved into the house next door in a well established neighborhood. Prostitutes come in a variety of guises.
“There is no Fannie Mae or Freddie Mac in the UK, but we still had a housing bubble…”
So, the flip side of that coin is that an economy is perfectly capable of putting people that can’t afford them into homes without these useless institutions.
I don’t make this stuff up. Serious economists are talking about it being time to let these things die or their functions taken over by banks.
“Greg has it exactly right. Fraud was rampant.”
On my street mortgage originators paid people to sign a mortgage and live in a house — a mortgage which was never paid and eventually was foreclosed upon.
These were $700,000 – $900,000 homes. One set of squatters stopped garbage pickup and began dumping their garbage in the back yard. The other set were 2 prostitutes — local police would not raid the house claiming they had “no probable cause”.
Both houses were completely trashed, then foreclosed upon, then reposed by a bank, then resold in a trashed condition.
The realtor working for the bank which was short selling the houses eventually paid the prostitutes and squatters several thousand dollars to get out of the houses and go away.
Could any of this have happened with out S&P and Moody’s rating bbb bonds as AAA? Granted my understanding of the crisis is dependent on “The Big Short,” but if the rating agencies are half as complicit as portrayed they ought to be high up on the fault list.
Some silly comments
Friedman did not make such arguments.
The English government was encouraging subprime loans. Plus the buy-to-let programs were causing trouble
Fannie and Freddie did not create the housing crisis, it was the straw that broke the back
Fraud was a problem I suppose in some markets, but where did the money come from? The FBI is not very good at preventing crimes like fraud, they come in after the fact.
BTW what politician was claiming that increases in home ownership was a bad thing?
One of the most regulated and most political sectors of the economy fails and you blame the private sector?
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