What the financial crisis isn’t: Part 2, the blame game
[Continued from yesterday’s Part 1.]
Yesterday we knocked off a handful of things the credit crisis wasn’t:
1. Not an asset bubble … a systematic under-pricing of risk.
2. Not caused by subprime lending … although that was the miner’s canary.
3. Not principally about the GSEs … because other financial institutions are in much worse shape
4. Not just about housing … although that is the biggest asset class
5. Not specific to the
If the conventional wisdom about our situation is all wrong, what about the blame game?
B. Who or what caused it?
6. It’s not proof of ‘under-regulation’ …
… provided we have a reasonable definition of ‘regulation’.
This would never have happened if we told them not to
‘Regulation’ can mean any of the following, which we can examine in the common example of driving, which is regulated.
Regulation: component pieces
· Conventions and protocols. Things done to make interacting with others easier. Driving on the right-hand side of the road.
· Licensing of practitioners. You have to pass a test, don’t you?
· Mandatory disclosures. Things that cause others to see what you’re doing: turn signals, brake lights.
· Required protections. To mitigate the damage posed by certain risks. Air bags.
· Prohibition of certain activities. Speed limits. Driving while drunk.
· Mandatory procedures. To reduce your risk and the risks to others. Wearing a seat belt.
· Financial collateralization. To assure that if you mess up, you pay and someone else can collect. Mandatory auto insurance.
None of these regulatory elements existed when cars were first invented, because advances in technology – whether physical, as in cars; medical, as in drugs; or financial, as in securitization/ derivatives – always outpace both marketplace response and regulatory schemas. (The story is told that in 1902, the entire state of
When the marketplace implodes – as it has, at least for certain overly levered bets like CDOs/ CDSs, and massive uncapped bets – the temptation is for regulators, arriving late to the wreckage, to wag their fingers at the wounded and add on new layers of thou-shalt-nots, overlooking that the marketplace itself, once it staggers to its wobbly feet, will impose its own new forms of discipline.
All the imaginable regulation wouldn’t have prevented the world from getting drunk on risk-taking.
Boy, am I going to have a financial hangover when this is done!
Nor would capital requirements exposed externally have done any good – we’ve already seen that capital can be almost as good as cash.
After the smoke clears, we will certainly have more, different, and better regulation (like Goldman and Morgan Stanley become bank holding companies) – but let’s not kid ourselves. This was a massive failure to appreciate and protect against counterparty risk – people were making huge bets that they could cover only if default rates stayed in low single digits.
We’re all totally rational …
7. It’s not the [
If the
The markets did this on their own.
Hey, the markets turned against us
A more vulnerable spot is the GSEs. Many, from Secretary Paulson on down, have criticized the GSEs’ “flawed business model.”
Lost in the shuffle has been that the GSEs originally had one business model – which even today looks sound, maybe with a proper capital charge – and quietly substituted another, much riskier one, as exhaustively and damningly detailed in the OFHEO report.
GSE Business Models
The original business model
“We arbitrage the risk curve by buying existing mortgage pools whose rates are higher than the cost to us of selling matching securities.”
Aided by an unlimited access to the implicit Federal guarantee, the GSEs’ business model became:
The revised business model
“We arbitrage maturity risk and credit risk by buying mixed bags of loans using our own paper to raise capital, turbocharging our balance sheet.”
Despite heroic efforts by OFHEO, GSE regulation was inadequate, in part because the GSEs had enormous political clout. This doesn’t prove the GSEs are prospectively uncontrollable, just that in the past they were inadequately controlled.
8. There’s no single culprit
Because human beings are natural pattern-makers – that more than anything is our distinguished survival skill, recognition and prediction – we want good things that happen to be the result of benign influences, and bad things to be the fault of villains. That’s why every demagogue finds a group to demonize, and why we invented Satan, Hannibal Lecter, and Ernst Stavro Blofeld.
“Please don’t disappoint me …”
In the financial mess, there’s been no shortage of press nominees for ultimate mastermind: Fannie Mae CEO Frank Raines, his predecessor and culture-imprinter Jim Johnson, Countrywide CEO Angelo Mozilo, “mark-to-market” and FAS 157, hedge funds, and short sellers.
Off with her head!
Off with all their heads!
Truth be told, none of them is solely culpable. Nor can we take comfort from claiming that even if not personally culpable, each was greedy. We’re all greedy – greed is intrinsic to the human condition. What we call greed is someone else’s greater cleverness, risk tolerance, or success. Unless the times are out of joint, naked greed backfires –Bunker Hunt nearly went broke trying to corner the silver market.
Bunker Hunt (middle) with his brothers – not broke yet
9. It’s not really rational
But then, panic never is.
It’ll look better in the morning
Okay, so we’re wrong about the situation, and wrong about the perpetrators. Are we similarly wrong about the way out (up)?
When you’re deep underground, look for a sign
[Concluded tomorrow in Part 3.]
Write a comment