One of my biggest disappointments in law school (there were many) was the uncritical embrace of Chicago-school economic theories by my torts professor. I couldn't believe that he bought that nonsense, and it depressed me further that we were expected to regurgitate it on exams. Maybe there's hope yet.
 

Great post, but two issues are conflated:

(1) The influx of economics into the law.
(2) The growth of supply-side ideas and libertarianism into economics.

(2) is mortally wounded. (1) on the other hand could continue in a different form. While Keynesian economics might not have much direct application to the law, behavioral economics really might. Instead of supply-side economics permeating the law, we could see behaviorial economics make an entry into legal research. There is some behaviorial law and economics already (Susskind et al. have seen to that), but I would expect its use to rise substantially.
 

Good point, Zathras. Behavioral economics indeed has potential. Perhaps what we are witnessing is a generational shift which was already under way between two modes of economic analysis within law--with the current economic crisis serving to inflict a severe wound on the first generation, hastening its demise?

Brian
 

I always took issue with my law and econ class that taught Coase's theorem, but never emphasized that its usefulness in reality was nill. Just like physics class, where you assume no friction, assuming no external costs means the theorem is useless for application. Obviously, some insights can be elucidated from it if one looks at it with a grain of salt. But my class always seemed to focus on the counter-intuitive finding of the theorem as a justification for ignoring the "wealth effects" that were always summarily dismissed as not important to the economics of the situation.

My torts prof, on the other hand, was more traditional, in his teaching that the burden should be placed on the party most able to prevent the harm. the law and econ class seemed to be an attempt to erase this principle, and go down a social darwinist path, that the injured should be required to take steps to prevent others from injuring them.

I think the behavioral stuff has potential, but the biggest failure in my mind was the class' failure to address the effects of wealth transfers. I don't know if this is a universal failing in the field, or specific to my class, but it certainly seemed to me at the time to ignore a huge repercussion of the policy conclusions the class was making. it didn't matter where the burden was shifted, and whether excess shifting to one group was problematic was never addressed. these were always dismissed as "wealth effects," that apparently cause no negative consequences.

@ Mark
I read the Powell law review - excellent! however it seemed more focused on the now less popular original intent, as opposed to original application or understanding (or whatever it's called now). any advise on law reviews on the framers feelings on these methods? there was a lot of good stuff on common law statutory interpretive method, though.
 

Did Posner actually think that economic history was at an end when free markets came back into vogue in the 80s and 90s?

There will always be government and private players who will attempt to game the system for their own benefit no matter the balance between the private and public sectors. Free markets give private players more opportunity to do so, while government regulation gives opportunities to pols and bureaucrats to do so, but both kinds of players can cause mischief under both circumstances.

In the case of the mortgage mess, we had both government gaming by pols attempting to extend mortgage credit to the non-creditworthy to buy their votes and banks creating opaque derivatives to trade away the risks loans to the non-creditworthy borrowers posed.

Therefore, government's proper role is negative - regulating bad market practices by private entities - and avoiding its own affirmative bad practices distorting the market to buy votes.

The claim that government deregulation caused the mortgage mess has no merit.

On the private side of the equation, these deriviatives had never been tried before and their failure could only be predicted with the perfect 20/20 hindsight from after the fact.

On the government end of the equation, the government stakeholders promoting the extension of mortgage credit to the non-creditworthy to buy votes blocked efforts to enact statutes and regulations to prohibit the practice in 2003 and 2006.

Becker's position is the most reasonable. Now that we have identified the problems, narrowly address the bad practices while leaving the markets as free as possible to create wealth.
 

I read the Powell law review - excellent! however it seemed more focused on the now less popular original intent, as opposed to original application or understanding (or whatever it's called now). any advise on law reviews on the framers feelings on these methods?

Yeah, it was written when Borkean originalism was still considered viable, so it was limited to that argument. Sorry, but I haven't seen any updates or extensions to the more recent attempts to justify originalism. If there isn't one, then someone should write it.
 

Law and economics assumes that individuals are rational actors who seek to maximize their interests

Law might be forgiven that view. No empirical study of individual behavior can make that mistake. We've known for 70 years that you can shape behavior that's hardly in the individual's interest. I'm sorry if Posner is ignorant of this. I guarantee you those who sold all those bad mortgage loans were well aware of it.
 

I'm reading Katherine V. W. Stone's "John R. Commons and the Origins of Legal Realism; or, the Other Tragedy of the Commons" that was prepared for presentation for a Festschrift that honored Morton Horwitz (author of The Transformation of American Law, 1870-1960) this past September. This essay provides valuable background on Commons' contributions as a political economist to the progressive movement in the early 20th century, focusing primarily upon "his early writings about the relationship between law and the economy" as it relates to the role of the state. This essay is available via:

http://ssrn.com/abstract=1311461
 

"Bart" DeBugblatter:

Therefore, government's proper role is negative - regulating bad market practices by private entities - and avoiding its own affirmative bad practices distorting the market to buy votes.

Spoken like a good brainless ideologue. It makes sense only if you adopt the (results-driven) mantra of the RW that the less gummint, the better gummint (obviously, if gummint wasdoing good things, it would be hard for the ideologues to 'argue' for less of it).

But if you think about it:

"government's proper role is negative - regulating bad market practices by private entities"

and

"and avoiding its own affirmative bad practices"

have inconsistent views of the gummint.

The first assumes that the gummint is smarter and more competent than the market, and can forestall bad practises.

The second assumes that the gummint is incompetent and can not help from commiting its own bad practises.

As I said, it takes a confoozed ... or very simple ... mind to hold both these beliefs at once. But that's no great feat for Bugblatter "Bart"....

Cheers,
 

Arne Langsetmo said...

BD: Therefore, government's proper role is negative - regulating bad market practices by private entities - and avoiding its own affirmative bad practices distorting the market to buy votes.

The first assumes that the gummint is smarter and more competent than the market, and can forestall bad practises.

The second assumes that the gummint is incompetent and can not help from commiting its own bad practises.

I presume you stopped reading my post after the paragraph quoted above and missed the entire discussion starting with: "The claim that government deregulation caused the mortgage mess has no merit" where I argue that the government did not have the competence to anticipate and forestall the mortgage mess.

I believe the government is sometimes competent enough to address bad practices like the mortgage mess after they become problems, but most of the time the problem must first become a disaster for the government to wake up. (See the rejection of Freddie and Fannie subprime reform in 2003 and 2006 and subsequent lack of action to present).
 

I argue that the government did not have the competence to anticipate and forestall the mortgage mess.

Your trust in the government is very selective. Apparently you only think the government is competent when it's invading countries which are sitting on our oil.
 

On the private side of the equation, these deriviatives had never been tried before and their failure could only be predicted with the perfect 20/20 hindsight from after the fact.

This is a financially illiterate statement. Plenty of people could and did predict the outcome which occurred.
 

Steve M said...

BD: On the private side of the equation, these deriviatives had never been tried before and their failure could only be predicted with the perfect 20/20 hindsight from after the fact.

This is a financially illiterate statement. Plenty of people could and did predict the outcome which occurred.

Who? When? What did they say? Were they members of our regulatory bureaucracy?
 

I agree with Mr. DePalma. If the government thought Fannie and Freddie had much of anything to do with the current situation, then its efforts to regulate those entities would have only been a sideshow, and would have result in negative effects on our economy, proving its incompetence.

(Mr. DePalma, you have been corrected on this issue more times than I can count. Fannie and Freddie do not originate (i.e. approve) subprime loans. I have previously posted analysis and statistics demonstrating a gargantuan percentage of the bad sub prime loans were originated by very lightly regulated private companies, i.e. Countrywide. This is not to say there weren't bad decisions made and Fannie and Freddie, but a) the regulations proposed by McCain and a couple of republicans were aimed at accounting games played by executives, and would not have affected the secondary market for sub-primes, and b) even if the government did crack down on Fannie and Freddie's purchasing of securitized sub prime and alt a loans, there is insufficient evidence to claim citibank, boa, chase, wells fargo, wachovia, wamu, etc, etc, wouldn't have continued to purchase them. There very well may have been a sufficient market to support the securitization. also, Fannie and Freddie were late to the securitization of sub prime and alt a purchasing game. So it isn't clear if they contributed to the cause of the problem, or if by the time they got to the party, we had already reached the tipping point. Moreover, it wasn't Fannie and Freddie extending loans to unqualified buyers - it was private institutions, taking a fee on crap loans, and passing the risk up, because of no regulation and greed. I also demonstrated previously how loans made under the CRA are actually well within an traditional default rate. this situation was caused, almost 100%, by private actors. lack of government regulation contributed to the failure to nip it in the bud, but the actual cause was not Fannie or Freddie. Lastly, the biggest factor in the current mess, aside from the bad originators, is the recession from the housing bubble's bust. as values on houses have gone down, and ARMs reset, people have negative equity in their houses, and speculators cannot turn a profit or pay the multiple mortgages. This causes even decent credit risk buyers to be crunched, and if they lose their jobs, its all over. and lastly part 2, this is systemic to the securitization of the mortgages, as these factors feed each other in a vicious cycle.

However, you know all this, as we have told you this time and time again. But instead of making constructive contribution to the discussion, you toss out repeatedly disproven, partisan motivated untruths. understand, people don't fight with you here because you have some kind of "conservative" viewpoint, they deride you because you don't base yourself in reality, no matter how many times someone corrects you. you just runaway from that thread, and go on to the next one, spouting the same false statements someone just called you on. Of course, this has also been said before...)
 

I am continually amazed, now in the mortage crisis and before in dot-com bust, at how many intelligent, sophisticated financial experts don't have the sense to come in out of the rain. They work up elaborate financial theories explaining why either (a) it will never rain again, or (b) due to their new financial model, people who invest in the new securities can stand in pouring rain and not get wet. Then they are astonished that it rains and people get soaked. Again.

I can only assume one of two things are at work. (1) Financial experts, staring down their microscopes at the technical minutia of the new investments develop a sort of tunnel vision and miss the broader picture that is apparent to any outsider. (2) They know their models are false, but hope to make money off of suckers they lure in. Actually, some combination of (1) and (2) seems the most likely.
 

nerp:

1) I never blamed the CRA for this mess.

2) Blaming the originators of the subprime mortgage loans to the non-creditworthy demonstrates a fundamental misunderstanding of this artificially created market.

In a politically motivated move to have the government provide mortgage credit to the non-creditworthy in order to use the expansion of home ownership as a campaign issue, Fannie Mae offered to purchase garbage subprime mortgages.

Countrywide and others were only too glad to make these garbage loans, take their cut and pawn off the risk to Fannie and presumably then to the tax payers. Indeed, the management of Countrywide and Fannie were completely in bed together on this scam, making campaign contribution kickbacks and mortgage sweetheart deals to the opponents of subprime reform like Dodd, Frank and yes Obama.

The bottom line is that the subprime market was a creation of the government.

3) Freddie was the one with the accounting problems which then attracted scrutiny of Fannie's subprime loan scam.

4) The proposed 2006 legislation required that Fannie's assets be viable. That provision would have made Fannie's further purchase of subprime mortgages illegal.
 

"Bart" DeBugblatter:

I believe the government is sometimes competent enough to address bad practices like the mortgage mess after they become problems, but most of the time the problem must first become a disaster for the government to wake up. (See the rejection of Freddie and Fannie subprime reform in 2003 and 2006 and subsequent lack of action to present).

Well, yes, if you're tallking ideological hacks, thugs, crooks, and incompetents like the Republicans running the country. And we see where that leads. But that's hardly inevitable or inherent in the nature of gummint. That was my point.

Cheers,
 

Steve M:

This is a financially illiterate statement. Plenty of people could and did predict the outcome which occurred.

Which, amasingly, was true of Hurricane Katrina and Iraq, as well (and some would include 9/11 in that too). What do you make of that?

"No one could have predicted ... that I'd be lying here eventually" ought to be engraved on Dubya's tombstone.

Cheers,
 

Beyond ideological arguments that are unresolvable, the real problem with Bart's position is his assumption that this was all a function of the governmental push to extend credit and homeownership to groups that were traditionally left out.

"60 Minutes" last Sunday had an excellent report about the expansion of teaser mortgages. These mortgages had NOTHING to do with Fannie and Freddie, the Community Reinvestment Act, or any other governmental push to extend credit to the poor. Rather, they were a classic product of the free market and the tendency to seek short-term profits while discounting long-term problems.

Essentially, regulators allowed banks and mortgage brokers to make loans that carried little interest up front, on the theory that the increase in the value of the house could allow a refinancing when the rate was going to go up. In other words, lenders and borrowers were essentially able to bet on the housing market's continued boom.

Worse, these lenders were then permittted to sell and securitize these teaser mortgages, which means that the lenders had no exposure for bad lending decisions or a market crash. Someone else would have to pay-- the homeowner, if he or she had the money to meet the obligation, or the purchasers of the security, if the homeowner went into bankruptcy.

And these mortgages are going to hit their interest adjustment points in the NEXT TWO YEARS, meaning things will get worse, not better.

The point is, this had nothing to do with any affirmative steps by the government. It was simply the choice not to impose price controls on banks, i.e., to allow them to structure their interest charges however they wanted, along with the choice not to regulate the mortgage securities market, that caused this.

And Bart's position is that you have to wait until bad things happen before regulating them. But this was TOTALLY foreseeable. Anyone could see that teaser mortgages were a terrible idea. So why wait until we are thrown into what might be a Depression before regulating them?

The reality is, the financial markets only work when they are carefully regulated. This isn't to say that Bart is wrong to be concerned about the dangers of wrongheaded regulation-- of course that is a legitimate concern as well. But the constant attempts of the right wing to blame this thing on liberals wanting to give loans to black people are truly offensive. While I agree promoting homeownership isn't such a great idea when the buyers can't afford the purchase, that isn't a major portion of the problem right now. The problem is that you had insufficient regulations to stop short-term speculation in a market that has to function over 30 year periods because of the nature of what is being bought and sold. Free market ideology doesn't work in this situation, because so many free markets are only rational in the short term.
 

Zathras said...

Great post, but two issues are conflated:

(1) The influx of economics into the law.
(2) The growth of supply-side ideas and libertarianism into economics.

(2) is mortally wounded. (1) on the other hand could continue in a different form. While Keynesian economics might not have much direct application to the law, behavioral economics really might. Instead of supply-side economics permeating the law, we could see behaviorial economics make an entry into legal research. There is some behaviorial law and economics already (Susskind et al. have seen to that), but I would expect its use to rise substantially.

Economics have been part of Anglo American law for centuries. That is unlikely to change because of the mortgage mess.

What Posner helped bring to legal analysis is one facet of economics - efficiency in the form of a cost benefit analysis of law.

The mortgage mess does not call into question the use of a cost benefit analysis of law because cost benefit analysis had no part in promoting the extension of mortgage credit to the non-creditworthy or mortgage loan derivatives. Indeed, panicked proposals for massive new regulation to the point of nationalization of large parts of the financial industry positively screams for the application of some calm and clear eyed cost benefit analysis.

Posner's questioning of his personal prior free market beliefs is a separate issue of government policy, not of the cost benefit analysis of law.

BTW, supply side theory is not a synonym for free markets in general as you appear to believe. Supply side theory simply posits that government revenues are maximized when marginal rates of taxation on wealth creation are kept low. As with cost-benefit analysis, the mortgage mess does not call into question the validity of supply side theory.
 

Dilan:

Worse, these lenders were then permittted to sell and securitize these teaser mortgages, which means that the lenders had no exposure for bad lending decisions or a market crash. Someone else would have to pay-- the homeowner, if he or she had the money to meet the obligation, or the purchasers of the security, if the homeowner went into bankruptcy.

This is the part I don't understand. Banks lose their incentive to avoid bad lending decisions when they can pass the costs on to someone else. But the purchasers of the securities have an obvious incentive not to let banks get away with anything. Why didn't these institutions refuse to purchase mortgages from any company unless it demanded proof of income and otherwise ensured that its borrowers would be able to meet their payments? (Ignorant question, I know, but I'm only an Enlightened Layperson).
 

Very well said, Dilan.

It is indeed a crock that these events were unforseeable. I'm no financial whiz, but two years ago I took all of my retirement funds out of stocks and parked it in a money market account. I didn't know when the crash would come, but I knew it was inevitable sooner than later. (I am now gradually buying back in.)

Others made the same move, based upon the same assessment. So the financial experts who had vastly more information have no excuse.

The root of the problem here was greed all the way around. Even Adam Smith and Hayek believed in regulation--just not stupid government interference or regulation designed to benefit particular interests at the expense of everyone else.

Brian
 

Dilan said...

Teaser mortgages (ARMs with low initial interest rates) did not have any substantial role in the mortgage mess and are thus a separate issue.

ARMs with low initial interest rates make perfect sense in an appreciating real estate market or in times of expected mid term low mortgage interest rates SO LONG AS refinancing to a different instrument is available because you are creditworthy and the mortgage loan market remains liquid.

The problems these loans have run into is that refinancing is not available because the mortgage loan market has become rather illiquid and/or because the borrowers themselves are not creditworthy.

I do not see a problem with the instrument per se so long as they are restricted to credit worthy borrowers and the borrower is fully appraised of the risk of not being able to refinance in the future.

I considered one of these instruments to purchase a larger home with an office for my firm so the money I would have paid in rent would instead go to home equity. This would have enabled me to pay low interest at the outset while my firm was starting out and higher interest later when the firm had a greater income. If the firm failed, my wife and I have great credit ratings and could have refinanced as we recently did for our current home. I never went in that direction because I could not find a house with a good commercial location. However, I appreciated the option the financial instrument gave me.

This all boils down to whether the citizenry should be treated as adults who have available to them the full panoply of choices and risks which life offers or children who have their choices circumscribed by others to avoid risk.
 

Brian Tamanaha said...

It is indeed a crock that these events were unforseeable. I'm no financial whiz, but two years ago I took all of my retirement funds out of stocks and parked it in a money market account. I didn't know when the crash would come, but I knew it was inevitable sooner than later. (I am now gradually buying back in.)

Markets always correct. This is perfectly foreseeable and should be expected by every investor. I invest in individual stocks and set an automatic sell point on them in case the market corrected. Thus, I bailed back at Dow 11,000.

Foreseeing a particular complex sequence of events and preempting them with a timely regulation is a completely different kettle of fish and is implausible if not impossible.

Even Adam Smith and Hayek believed in regulation--just not stupid government interference or regulation designed to benefit particular interests at the expense of everyone else.

No one here, including this free marketeer, is calling for anarchy with no laws regulating the economy. The question is how many laws are necessary to deal with the current problems and what is the cost of such laws - because there is always a direct or opportunity cost.
 

Brian: The libertarian end of the range failed to grasp the danger of deregulation of financial markets and underestimated the risk and depth of the current economic crisis--an economic shock that appears to be severe enough to trigger a genuine depression.

I think it's impressive that even members of conservative think-tanks like the AEI, who seem much more interested on pinning blame on a congressional desire to create low-income homeowners (conveniently putting aside the "Ownership society" rhetoric of the current administration), find themselves compelled to point to a lack of regulation as the ultimate cause of the credit crisis.
 

Foreseeing a particular complex sequence of events and preempting them with a timely regulation is a completely different kettle of fish and is implausible if not impossible.

No one here, including this free marketeer, is calling for anarchy with no laws regulating the economy.

This makes a certain degree of sense. I would probably not object to financial deregulation if it took place in this sort of spirit. If old regulations no longer fit contemporary realities, repeal them, but with the understanding that when a new system develops, it, too will have to be regulated. Repeal them in the spirit that the new system should be watched closely and appropriate regulations enacted when problems appear.

Unfortunately, financial deregulation has not taken place in this spirit. It has taken place with the assumption that the system is self-regulating and no government action is needed. The current problems have been apparent for some time. In a less anti-regulatory climate, we would have taken action before they reached such a level of epic fail.

This all boils down to whether the citizenry should be treated as adults who have available to them the full panoply of choices and risks which life offers or children who have their choices circumscribed by others to avoid risk.

For the most part, if investors don't know enough to come in out of the rain, they should have the right to get soaked. Unfortunately, in finance levels of collateral damage are unacceptably high.

It is also true that in home mortgages you are often dealing with parties with vastly unequal degrees of knowledge, sophistication, and power. To ignore this fact is a form of reality-denying.
 

This all boils down to whether the citizenry should be treated as adults who have available to them the full panoply of choices and risks which life offers or children who have their choices circumscribed by others to avoid risk.

The problem is that the risk isn't individualized. Rather, if you get too much pent-up risk in any part of the economy, you get a crash that can hurt a ton of people.

Whereas if you regulate, maybe Bart DePalma doesn't get his teaser loan that he could responsibly enter into while being both able and willing to take the risk, and that may mean a slightly slower economic growth rate, but Bart DePalma also benefits from forestalling the crashes.
 

"Plenty of people could and did predict the outcome which occurred."

While there's a trivial sense in which anything which somebody predicted was "predictable", by "predictable" we usually mean "with some reliability", not "a stopped clock is right twice a day". But I'm open to the possibility that somebody was crying in the wilderness about this.

They clearly didn't have much pull with the government, and Obama was among those tugging the other way, to his considerable profit. Which renders the part the economic crisis played in putting him in office rather absurd.
 

Mr. DePalma,


1) I never blamed the CRA for this mess.

From the context of your post, I interpreted your claims to mean this. Apologies.


2) Blaming the originators of the subprime mortgage loans to the non-creditworthy demonstrates a fundamental misunderstanding of this artificially created market.

Did you read the NY Times article you linked to? It said Countrywide was threatening to force Fannie out of the market, because it could simply sell to Wall Street. It says Fannie's business had gone down 56% the year before Mudd took over (2003). If Wall Street is buying, the market isn't artificial. To key passages illustrate this:

”Between 2001 and 2004, the overall subprime mortgage market — loans to the riskiest borrowers — grew from $160 billion to $540 billion, according to Inside Mortgage Finance, a trade publication. Communities were inundated with billboards and fliers from subprime companies offering to help almost anyone buy a home.”
Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers — more than three times as much as in all its earlier years combined, according to company filings and industry data.

If Fannie caused this by creating an artificial market, why did the subprimes boom between 2001 and 2004? How did Fannie create an artificial market if it didn't buy or insure them until 2005? You have this completely backwards – the market existed because the private markets created it and ignored the risk. Fannie foolishly jumped in at the end, causing additional problems, I fully acknowledge, but the cause is the private markets. I couldn't have linked to a better article to prove the point. Shortest summary possible – by the time Fannie started buying or insuring the loans, the risk had already been created. Would a decision by Fannie not to participate lessened the crisis? I actually think it would have made it worse. As long as Fannie, and ostensibly the Federal government, was guaranteeing these loans, those subprimes with the guarantees would not be as toxic as those without. Those without the federal guarantee, on the other hand, are the ones held by banks that make them distrust each other.

In a politically motivated move to have the government provide mortgage credit to the non-creditworthy in order to use the expansion of home ownership as a campaign issue, Fannie Mae offered to purchase garbage subprime mortgages.

No. Fannie felt pressured to jump in because of the politics, but it was the originators pushing the loans. Fannie wanted to remain relevant. Fannie was afraid if it didn't take part of the subprime business, it was gonna be cut out of the standard market by the originators selling to Wall Street. Countrywide, et. al. were using the leverage they had to force Fannie into the market. Bad move, yes - but you have causation in reverse.

Countrywide and others were only too glad to make these garbage loans, take their cut and pawn off the risk to Fannie and presumably then to the tax payers. Indeed, the management of Countrywide and Fannie were completely in bed together on this scam, making campaign contribution kickbacks and mortgage sweetheart deals to the opponents of subprime reform like Dodd, Frank and yes Obama.

They were making the loans long before Fannie came in, as the article says. Countrywide wanted to get more profits, so it wanted to sell the loans upstream, and the biggest buyer out there wasn't in the market. So they put the screws to Fannie, who made a bad business decision, and jumped in. Countrywide needed Fannie to buy them so it could sell more.

The bottom line is that the subprime market was a creation of the government.

You simply couldn't be more wrong, and the evidence you cite expressly says the same. The subprime market existed before Fannie jumped in. This problem was not caused by Fannie. Contributed to – perhaps. But it was entirely caused by the private market and lax regulation.

3) Freddie was the one with the accounting problems which then attracted scrutiny of Fannie's subprime loan scam.

No. Both Freddie and Fannie were playing accounting games, Fannie trying to inflate its stock price by making big promises on future returns to increase the executives bonuses. The scrutiny came in 2003, before Fannie entered the subprime market. It was because of the executives gaming the stock market to get larger bonuses. The scrutiny in 2006 came because Fannie was becoming over leveraged on its insurance. It began buying so many loans, subprime, alt a and standard, but was not charging appropriate fees to give itself enough capital to cover its insureds if it suffered a loss. It was undercapitalized, but no one was (as of yet) concerned with the actually liabilities, just the amount. This mostly occurred because the housing bubble inflated home prices (and loan sizes), yet Fannie's fees for insurance were not sufficiently increased to match the rate of home value inflation. Certainly, Fannie's acquisition of subprimes was adding risk, but its failure was not charging sufficient premium to its buyers for the insurance. Like AIG (another wholly private catastrophe), Fannie had made more promises than it could pay, if things went sour. But this was after the mess was made – the subrprime loans were already out there, and the ARMs were already ticking to reset. Like a accident victim getting burned when his car catches on fire after he is T-boned by a drunk driver, the fire certainly doesn't help his injuries, but it wasn't the cause of them – the drunk driver was.

4) The proposed 2006 legislation required that Fannie's assets be viable. That provision would have made Fannie's further purchase of subprime mortgages illegal

Debatable. If the private markets were still buying, then no. Since there would have been a market for the loans, they were viable. There were tons of pundits (Kudlow, for one) claiming there was no subprime problem as late as december 2007 (if not later). The fools in the market still believed no crisis existed on the horizon. The credit markets began freezing up about then, so certainly rational minds could have seen these securities were not worth that much. But Fannie was in trouble because it was undercapitalized to cover losses. So I don't think one can really say it would have been illegal in 2006, maybe in 2007, more likely at the beginning of 2008, and certainly now, but, as I said before, it doesn't matter – the mess was made way back in 2001. did Fannie's actions fan the flames on the already existing situation? Its a good debate. But the cause of the mess is the private markets. Fannie just stupidly jumped on the bandwagon after the fact. The Titanic was already taking on water, and Fannie asked to come aboard.
 

For the benefit of Brett and Bart the following is from a Sept. 21 '08 thread here at Balkinization:

Glenn Greenwald in a post on the crisis links to a 2002 discussion of derivatives by Warran Buffett to his investors. It concludes:

"In our view, ... derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

# posted by Occasional Observer : 8:56 PM
 

Enlightened Layperson said...

It is also true that in home mortgages you are often dealing with parties with vastly unequal degrees of knowledge, sophistication, and power. To ignore this fact is a form of reality-denying.

You identify a major gap in our K-12 education system - a lack of any instruction on how the economy works and how to deal with personal financial life issues.

The citizenry's ignorance of the economic facts of life is staggering. However, rather than accepting this sad state of affairs and treating the citizenry like children unable to handle their own economic affairs, I would suggest that it might be wise to require a two semester course during the senior year of high school instructing students on bank accounts, loans, commercial contracts, mortgages and investment vehicles.
 

Mr. DePalma,


The bottom line is that the subprime market was a creation of the government.

You simply couldn't be more wrong, and the evidence you cite expressly says the same. The subprime market existed before Fannie jumped in. This problem was not caused by Fannie. Contributed to – perhaps. But it was entirely caused by the private market and lax regulation.



I actually need to add a caveat - your statement has a measure of truth if you mean the Fed created the market. By keeping interest rates artificially low for so long (probably to help G. dubbs get elected in 2004), the Fed created the condition necessary for Countrywide to assume a ton of risk at a very low price. It could originate cheaply through borrowing, and then sell risk upstream. It didn't get in trouble until rates came back up. If this is the process you are referring to when you say the government created the market, I would agree the government substantially contributed to creating the subprime market.

Fannie still had nothing to do with it, though.
 

Bart De Palma, 1) I never blamed the CRA for this mess.

Well, in the same 9-21-08 thread referenced above you wrote:

This has been a Dem only show that has been brewing since Carter, was accelerated during Clinton and was Dem filibustered when Bush then McCain tried to clean up the Dem mess.

And you linked to an Investors Business Daily editorial which stated,

"The Carter-era Community Reinvestment Act forced banks to lend to uncreditworthy borrowers, mostly in minority areas. Age-old standards of banking prudence got thrown out the window. In their place came harsh new regulations requiring banks not only to lend to uncreditworthy borrowers..."

Oddly, you parroted that language then and you continue to do so.
 

nerpzillicus said...

BD: Blaming the originators of the subprime mortgage loans to the non-creditworthy demonstrates a fundamental misunderstanding of this artificially created market.

Did you read the NY Times article you linked to?

”Between 2001 and 2004, the overall subprime mortgage market — loans to the riskiest borrowers — grew from $160 billion to $540 billion, according to Inside Mortgage Finance, a trade publication. Communities were inundated with billboards and fliers from subprime companies offering to help almost anyone buy a home.”

Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers — more than three times as much as in all its earlier years combined, according to company filings and industry data.

How did Fannie create an artificial market if it didn't buy or insure them until 2005?

Fannie and HUD started fueling the subprime market under Clinton Administration pressure back in the 90s, not starting in 2005. The NYT simply noted the enormous number of loans Fannie purchased during the latter period after 2005 as an illustration of the size of the market before the bubble burst.

4) The proposed 2006 legislation required that Fannie's assets be viable. That provision would have made Fannie's further purchase of subprime mortgages illegal

Debatable. If the private markets were still buying, then no. Since there would have been a market for the loans, they were viable.

Viability is determined by the ability of the borrower to pay back the loan under generally accepted mortgage lending standards. Fannie threw these standards out the window in the 90s. The proposed bill was meant to return Fannie to those standards.

The fact that Countrywide and similar ilk were also defrauding private investors into buying these junk mortgages by burying them into derivatives is not a standard for viability.
 

mattski:

I cited the IBD article to support the argument I posted, not for its other commentary.

While the Carter era CRA my have been a harbinger of things to come, it was the Clinton Administration pressure on Fannie and private lenders to gut generally accepted mortgage lending standards to extend mortgage credit to the non-creditworthy that created the foreclosure crises when these non-creditworthy borrowers predictably defaulted.
 

Ah yes, the mortgage meltdown was Clinton's fault. That's Shrub's shrill cry these days too. Not my fault! It preceded me, don't you see!!

And who was President for the last eight years? And over all that time, what did he do to identify the problem? What did he do to solve it? Having eight years to do something about it?

Yep, that's what Presidents do. With all that power, that's the idea, yes.
 

The citizenry's ignorance of the economic facts of life is staggering. However, rather than accepting this sad state of affairs and treating the citizenry like children unable to handle their own economic affairs, I would suggest that it might be wise to require a two semester course during the senior year of high school instructing students on bank accounts, loans, commercial contracts, mortgages and investment vehicles.

Hear, hear. I have believed for a long time that high schools should teach a mandatory class in personal finances. Unfortunately, even if your recommendation were adopted tomorrow, it would take some time for the general level of sophistication to catch up, and in the mean time there will be plenty of lenders eager to take advantage of the knowledge gap.
 

jpk said...

Ah yes, the mortgage meltdown was Clinton's fault.

And who was President for the last eight years? And over all that time, what did he do to identify the problem? What did he do to solve it? Having eight years to do something about it?

Treasury came to Congress in 2003 asking for legislation to address the Fannie problem. The congressional GOP did not give the issue much importance and the congressional Dems openly opposed cutting off the gravy train to their voters.

The congressional GOP started waking up in 2006, but the McCain cosponsored bill was blocked by Dodd and a united Senate Dem caucus threatening a filibuster.

After the Dems took over in 2007, nothing further happened on the subject.

Yep, that's what Presidents do. With all that power, that's the idea, yes.

The President has no power whatsoever over Fannie. Congress needed to provide legislation.
 

Yes, yes, I know. The Repubs had the Senate, the House, the Court, the Presidency. Bush had the power to illegally spy on Americans; to torture prisoners; to invade, overthrow, and occupy other lands; to stack the federal government with incompetent political hacks; to overturn Acts of Congress with signing statements; to sabotage government employees who spoke the truth; to employ a mercenary army to violate the law overseas; yes, he had all that power, but when it came to preventing the biggest financial meltdown in modern times -- oh! gosh! oh my goodness oddness gracious! that boy was fresh out of power. Love to help! Just can't do it!

Of course, consistent with this twaddle, we'd see Shrub speaking to Congress, urging them to prevent the oncoming rush of defaults, explaining the problem, demanding action, now, before it was too late. We all remember him doing that, right? Right? No? Oh wait; that's because he didn't do it. He did nothing of the kind. And the notion that that mean old Congress prevented him from doing something, let us not mince words, is hogwash.

But then neocon utterances are routinely hogwash. We will be welcomed as liberators. The war won't cost us much. Saddam had WMD and was going to give 'em to his buds in al Qaeda. Either you're with me or you're with the terrorists. We do not torture. It's the soft rain of nonsense that fell on this land, melting sense, washing away meaning, filling the cesspools so beloved of the Republic Party.

So really, why not one more lie? Yes, it was Clinton's fault. It was the Congress's fault. It was the banks' fault. It was anyone and everyone's fault except the guy who for eight years was the most powerful man in the country, and who kept telling us that his wartime powers gave him even more power. With great power comes great responsibility? Not with this guy.
 

Mr. DePalma,


Fannie and HUD started fueling the subprime market under Clinton Administration pressure back in the 90s, not starting in 2005. The NYT simply noted the enormous number of loans Fannie purchased during the latter period after 2005 as an illustration of the size of the market before the bubble burst.

With a pilot program at 24 banks? are you kidding? 30 year fixed rate at 8%?

The boom occurred during a time Fannie wasn't buying. If Fannie wasn't buying, then clearly the loans were not being originated based on reliance upon Fannie buying them. Nothing in the plan about ARMs, ballons, interest only, etc., etc. How does Fannie lose 56% of business in 2003? You are grasping at straws.

Fannie was the only one who could do this, because Greenspan kept rates high during Clinton's term. Banks could not issue mortgages to higher risk people, because the cost of borrowing the money, plus the risk of default created too large of a APR for anyone in the slightly below standard credit requirements to afford. Further, why take a risk on mortgages, when the stock market was flying high? Fannie was trying to direct money into homeownership, because the market, at that point, preferred to place the money elsewhere. If Fannie guarantees it, though, the banks could afford the risk, still based on strict credit requirements, albeit lesser ones, and the investments are no longer not competitive with other places to put money. But Fannie wasn't buying everything, just stuff (for the pilot program, it should be emphasized) that qualified under the program.

The boom occurs in 2001, when the Fed rate goes to 1% after September 11, and stays there. the stock market had tanked, and people wanted a new place to put their money. (remember, even at the highest dow under Bush in 2007, the market had only gained about 25% from Clinton, or only 3.5% a year.) At that point, everyone in the private market gets exuberant, and begins originating poorly documented loans, because everyone is buying the securities. But this is the key point - the private market is originating, but Fannie isn't buying, Wall Street is. Fannie doesn't get into it until 2005.

I don't know all the details about the program, but once money became cheap, banks and investors didn't have as much need for federal guarantees. In fact, as is clear from the article you cited to originally, no one in 2001-2004 is even going through Fannie. Its all private, and the pilot program is rendered moot by cheap money. With home prices inflating too fast, investors didn't worry about defaults, since the foreclosed property would be worth more than the original loan.

Just because Fannie had a small program back in 1999, with terms that were oppressive compared with what was available two years later (i wonder how many of the Fannie pilot recipients refinanced in 02-04?), doesn't mean Fannie created the undocumented subprime market. This is an exercise in trying to pin blame on democrats, with no basis in reality.


Viability is determined by the ability of the borrower to pay back the loan under generally accepted mortgage lending standards. Fannie threw these standards out the window in the 90s. The proposed bill was meant to return Fannie to those standards.

The reference to the 90's is completely untrue. even your second article is dated september of 99. and that's a pilot program. and as i showed above, there was no reason for the program post 1% fed rate. The market 2001-2004 was all private. stop trying to fix the facts so that you can blame democrats. everybody has some fault here, but this is ridiculous. Fannie's program was no longer competitive once money was cheap. Fannie's program still required tons of documentation and strict standards. Yes, they lowered the minimum threshold, but these weren't alt a, no job verification loans. these weren't ballon, or ARM, or interest only. And the relative size of this market to the private market is unknown, but do to the growth in 01-04, Fannie could not have been significantly involved in the market since it wasn't buying then.

And then there is the obvious question - if Fannie was such a key player in creating the subprime market, and was wholly responsible for it, and the private market only went along because Fannie was insuring crap loans, why did Countrywide basically have to blackmail Fannie into it at the end of '04? Why doesn't the federal government simply pay out the defaults on Fannie guaranteed mortgages? Sorry, this just doesn't make any sense. the real reason is Fannie didn't insure that significant of an amount of the market, even after '05. it is the privately created, privately bought, and non Fannie loans that are the problem.

The fact that Countrywide and similar ilk were also defrauding private investors into buying
these junk mortgages by burying them into derivatives is not a standard for viability.

This, on the other hand, is a much more honest discussion. As I said, it depends on how you define viability, whether there is an objective viability or whether the market believes it is viable. Your point is well-taken, and if the law was enforced in the manner you suggest, you are absolutely correct that it may have reduced the undercapitalization of Fannie.

That said, i have perused the bill, and see nothing about viability. Admittedly, I haven't read the whole thing thoroughly enough to be sure there is nothing in there, but I did see an awful lot about undercapitalization, golden parachutes, and controlling executive's management, along with provisions for receivership if the executives screw around. Didn't see anything directly regulating the quality of assets. Please cite the section, thank you.
 

Nerp:

The cites I posted speak for themselves. You are welcome to provide contrary evidence to back up your claims.
 

Mr. DePalma,

I don't have to. Your cites contradict your theory. That's the point.
 

I cited the IBD article to support the argument I posted, not for its other commentary.

Bart, it was an editorial, not an article.

And your arguments, then and since, have merely parroted this right-wing talking point about "non-creditworthy" borrowers. As it so happens, this right-wing editorial placed the CRA at the center of it's argument.

That makes it kind of silly, not to say nonsensical, to try and have one without the other. Although, granted, there are plenty of "non-creditworthy" borrowers of a completely different stripe involved in the housing bubble, ie, speculators. But these suspect borrowers were hardly the focus of programs like CRA and they thus escape your radar and your wrath.
 

it was the Clinton Administration pressure on Fannie and private lenders to gut generally accepted mortgage lending standards to extend mortgage credit

The President has no power whatsoever over Fannie.

One of these things is not like the others,
One of these things just doesn't belong,
Can you tell which thing is not like the others
By the time I finish my song?
 

PMS:

Fannie chief Raines was a Clintonista and Andrew Cuomo's HUD sued private lenders for declining to lend to the non-creditworthy arguing that it was racist.

In contrast, I am unsure what standing Bush would have to sue Fannie and private lenders for making garbage loans.
 

From my fax today, I find I can get you a loan for your residential home with no asset or income verification and no credit history, for the low, low rate of only 13% at 4 points cost. Of course, there's a two-year prepay penalty, and it's a 5/25 ARM.

Thank goodness the real problem is overregulation. Whew!

In contrast, I am unsure what standing Bush would have to sue Fannie and private lenders for making garbage loans.

Little to none, I would imagine.

June 17, 2002:

First of all, government sponsored corporations that help create our mortgage system -- I introduced two of the leaders here today -- they call those people Fannie May and Freddie Mac, as well as the federal home loan banks, will increase their commitment to minority markets by more than $440 billion. (Applause.) I want to thank Leland and Franklin for that commitment. It's a commitment that conforms to their charters, as well, and also conforms to their hearts.

This means they will purchase more loans made by banks after Americans, Hispanics and other minorities, which will encourage homeownership. Freddie Mac will launch 25 initiatives to eliminate homeownership barriers. Under one of these, consumers with poor credit will be able to get a mortgage with an interest rate that automatically goes down after a period of consistent payments. (Applause.)

Fannie Mae will establish 100 partnerships with faith-based organizations that will provide home buyer education and help increase homeownership for their congregations. I love the partnership.



All of this as part of "America's Homeownership Challenge"--an attempt to "increase the number of minority homeowners by 5.5 million families by the end of the decade," including a pledge to "substantially increase by at least $440 billion, the financial commitment made by the government sponsored enterprises involved in the secondary mortgage market, specifically targeted toward the minority market."

Given this engagement with (some might say pressure on) the mortgage industry, one does indeed wonder how Bush could possibly sue Fannie Mae for buying iffy loans!
 

Thus peters out another Bart-jacked thread.

Bart, you had your ass handed to you up, down & sideways. If it wasn't for fantasy & forgetfulness you'd be crushed by the weight of your own shame.
 

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