Thursday, November 17, 2011

Blaming Freddie and Fannie

The 2008 financial crisis looks to me like very clear evidence that the more unregulated free market economic system that has been implemented in the US since 1980 has failed relative to the more regulated market system that existed prior. This disconfirms a lot of right wing economic theory in my mind.

But of course in the mind of right wingers it doesn't and a key pillar of the argument is that the blame lies with Freddie and Fannie. The theory is that the government not only encouraged, but mandated that banks issue risky loans. That's Thomas Sowell's assertion here.

But as far as I can tell that's just not true. The Community Reinvestment Act did not require banks to make loans to the poor and risky. What it did was disallow redlining. Redlining was a process whereby services and the costs associated with them were determined by simply drawing a "red line" on a map and saying those on one side of the line get one set of services at a certain cost and on the other side people get other services and costs. The effect was to generally make things tougher for minorities. What the CRA did was it required institutions to use consistent standards that were not based on which side of the tracks someone lived on but based on other factors, like a person's financial status.

There were a number of causes for the crisis in 2008. Several are discussed in this article that also addresses this myth that Freddie and Fannie are to blame. These causes don't support free market dogma. But why are people blaming the CRA? In fact CRA regulated institutions were less likely to make subprime loans. Further they were less likely to repackage and sell them. According to Wikipedia "every empirical study that has looked at CRA loans has concluded that they were safer than subprime mortgages that were purely profit driven, and CRA loans accounted for a tiny fraction of total subprime mortgages." Wikipedia cites this paper from Michael Simkovic out of Seton Hall and Harvard to justify that claim.

So if every empirical study shows that Freddie and Fannie were not responsible where are these claims coming from? The paper from Simkovic provides insight, so I will quote it below:
A. Industry has sought to defend itself by blaming government

Arguments that government policy primarily caused the financial crisis have generally been made in the context of advocacy paid for by the financial industry rather than through empirically substantiated academic scholarship. Many of the most forceful proponents of these arguments—such as mortgage consultant Edward Pinto and Financial Crisis Inquiry Commission dissenting member Peter J. Wallison136—are not academics but are instead affiliated with “think tanks” such as the American Enterprise Institute (“AEI”) which fundraise based on their efforts to deflect blame for the financial crisis from private financial institutions and which are committed to advocating free market ideology and limited government.137 AEI “is governed by a Board of Trustees, composed of leading business and financial executives.”138 During the five-year period from 2005 to 2009, the vast majority of its revenues came from annual donations.139

AEI’s 2009 report trumpeted Wallison and other AEI-funded writers efforts to deflect blame for the financial crisis from private financial firms and to place the blame for the financial crisis on government policies.140 The report also highlighted AEI’s ability to influence “Financial Regulation’s Future” because of Wallison’s role on the Financial Crisis Inquiry Commission.141 The report suggested that Wallison would likely use the opportunity to blame the GSEs for the financial crisis and to combat more comprehensive financial regulation.142

AEI’s 2010 annual report points out that in his role as a dissenting member of the FCIC, Wallison did in fact blame government policy for the financial crisis.”143 The report reiterates Wallison’s opposition to regulation and his ability to influence legislation.144

Wallison’s unwavering efforts to blame GSEs and government policies for the financial crisis were noted by other members of the commission, including fellow Republicans, who were often critical of his single-minded approach.145
For further analysis of Wallison and Min's apologetics for the financial industry, go here. I keep coming back to this point. You might think it strange that such smart people can argue in this way when all of the empirical evidence is against them. But it makes perfect sense when you recognize that confusing people on behalf of wealth is their job.


Chad said...

Eventually - if you tell yourself something enough - in your mind it will be true!

I am rooting for you Jon.

Fact - Freddie and Fannie should NEVER been born, it is not supported by the Constitution. The free market never had an opportunity to work correctly due to these beasts.

Another gov't ran program that is failing, yet another in the long line of failures by gov't.

Jon said...

Freddie and Fannie failed us? Did you read my blog post?

Is the Air Force supported by the Constitution? What about immigration law that you like so much? Where in the Constitution does it say the federal government has the right to limit the number of immigrants coming here?

For once talk about the unconstitutional action our government engages in that helps rich people. Do you know how much corporate welfare there is? Our government just gives away huge sums to corporations to assist them in setting up shop overseas. I haven't seen you complain about that. Our government engages in wars on behalf of wealth of course. You know why we went to Libya. You know that if they had carrots and potatoes nobody would care. They have oil. You know who likes the oil. Super wealthy stock holders and owners. This is the world we live in, Chad. So you can complain about government action that helps the poor all you want. If they hadn't done it our financial crisis would have been much worse. But we live in a world where our government is very unconstitutional. You can't ask that the government stop helping the poor without first asking them to stop helping the rich.

Our entire economy runs on paper money. The Constitution does not grant the federal government the authority to issue paper money. So where are your complaints about that? Should that stop right now? Our entire financial system would collapse.

It really is unfair I think to focus on the kind of unconstitutional behavior that hurts the poor while ignoring that which hurts the rich. Ron Paul understands that. He says he's not going to dismantle Social Security and Medicare right away. Sure, he disagrees with them. They are unconstitutional. But we're in wars all over the world. We give Israel billions. We give corporations billions. We let corporations run the FDA and other organizations. Let's resolve these first. Then we can talk about the government assistance to the poor and needy. That should be our first priority. Why do you reverse that?

Vinny said...

Hospitals are required by law to treat anyone who shows up in the emergency room regardless of their ability to pay. However, they try to pass the costs on to paying patients and they don't go out to solicit people without insurance to come in for treatment.

The "blame-the-CRA" crowd would have you believe that sophisticated, profit-seeking bankers responded to a government requirement that they make a certain number of bad loans by making as many of those loans as they possibly could without trying to recoup the costs on more profitable transactions.

I don't see how anyone could possibly have any faith in free-market economics if they really think that banks would go ape-shit crazy making bad loans just because the government encouraged it.

Sheldon said...

I have to say you do an admirable job with your blog posts and are tenacious and fearless in the face of your regular righty true believers, Chad and Hispanic Pundit. Keep up the good work.

Jon said...

Thanks Sheldon. It's a labor of love.

HispanicPundit said...

Jon writes, The 2008 financial crisis looks to me like very clear evidence that the more unregulated free market economic system that has been implemented in the US since 1980 has failed relative to the more regulated market system that existed prior.

Reminds me of this quote from Larry Summers:

"As for [Milton] Friedman -- I'm not so sure he looks bad. What is most screwed up today? GSEs, Citibank, regional banks. What is most regulated? Same list. What is least screwed up? Hedge funds and the like. What is least regulated? If regulation means the jihad against short selling that the Securities and Exchange Commission is engaged in, then god help us all."

Anyway, carry on...

HispanicPundit said...

I should also make clear that I don't necessarily disagree with your post...some points I'd even agree with.

If you really want to know my position on the causes of the financial crisis, they are very similar to this EXCELLENT post by Megan McArdle (you know, the person who predicted the financial crisis LONG before Paul Krugman and never actually recommended a housing bubble right at the start of the housing bubble...).

Jon said...

Megan predicted a financial crisis? Where are you getting that? She said housing prices are at a point where you'd call them a bubble. Talk of housing prices reminded her of talk of tech prices. That's not the same as predicting a financial crisis. It was Krugman that predicted the financial crisis while Megan wasn't too concerned in 2008. Recession likely-ish, but she's not too fatalistic.

In other words the economist knew what was going on. The English Lit major thought housing prices sounded like tech prices but she was unable to connect the dots.

HispanicPundit said...

Let me rewind: McArdle predicted the housing bubble LONG before Krugman...AND...had enough foresight to NOT recommend a housing bubble at the beginning of the housing bubble. Readers can see our discussion on this here.

I still rate it 2-1 McArdle.

Jon said...

OK, but get your facts straight. Your sounding like Sowell. Megan did NOT predict a financial crisis and Krugman did. Megan was able to look at a chart and realize home values were going up a lot, but she had no idea what the implications were. Krugman not only saw the bubble, he saw what it would do (pull us out of the 2003 slump) and then by 2005/2006 he knew that this bubble (which he recommended be fueled to bring us out of 2003) had been fueled too long and was going to lead us into 2008 and a financial crisis. Krugman was mapping the thing the whole way, telling us exactly what it would do throughout the decade before it happened. Pull us out of the 2003 slump but if it goes too long draw us into the 2008 downturn. Megan is blissfully unaware of all of it. Unaware that the bubble was needed to pull us out of recession in 2003. Unaware of the looming disaster that was 2008. But because someone said something that sounded like what was said of tech stocks she thought there were some similarities. You say it's 2-1 McArdle. I say it's 10-1 Krugman.

HispanicPundit said...

Can you provide evidence for your "facts", specifically this claim: "Megan did NOT predict a financial crisis and Krugman did."

Also, let me reiterate the point I made here (which you have yet to clarify):

You are arguing that yes, the bubble started around 2002, yes Krugman's advice likely exacerbated the bubble and yes, the bubble was very destructive - but because Krugman was right about the Keynesian assumption underlying the advocacy for more bubble - and really, I would say 70 to 80% of all economists are neokeynesian, anyway, so Krugman's "insight" is hardly new - he should be given credit for that?

McArdle on the other hand, was already onto the bubble in 2002. Long before Krugman was. In fact, she has two advantages over Krugman: predicted the bubble long before Krugman did, and had enough foresight to NOT recommend a housing bubble. But this is less impressive to you than Krugman saying "hey, if we artificially inflate the housing sector that will create more jobs"?

We can move onto your other claims after you provide proof (if you read the thread here, you will see that you have made claims before which when asked to substantiate turned out to be widely exaggerated - so now I insist on proof of your claims when discussing the Krugman/McArdle distinction).

Jon said...

Megan saw that housing was in a bubble in 2002. Meaning she said "Hey, what that guy said sounded like what was said of tech stocks." You say she had enough foresight not to recommend a bubble to fuel consumption. Yeah, so did my cat. It's not impressive to not recommend something.

By 2008 the bubble had popped. Prices peaked in 2006, so prices were much lower by the beginning of 2008. Megan indicates that she has no idea what the implications of this are. She doesn't understand that our economy has been fueled by consumption that relied on the booming housing market and that with the fall in prices there's nothing to replace it. Krugman does, and he sees a recession coming (see the video you linked to). He says at this link that the hope was the economy would have recovered by the time the housing bubble petered out and that bubbling would no longer be needed. But he can see in May of 2005 that this is not the case and there's trouble ahead.

You could say that predicting a recession is not the same as predicting a financial crisis. Krugman may not have known about the derivatives market and CDO's, how the ratings agencies were paid for by GS. It was illegal for the public to know what was happening. That was the free market madness. A specialist or insider could know that where a columnist might not. So I'm not expecting Krugman to map it in that kind of detail. What I do expect a good economist to do is accurately understand the facts of the world and at least tell us what the implications are. Krugman can do that. I don't see that Megan is to the level of Krugman. Not that she's an idiot. Like I said, recognizing the bubble and the parallel to tech stocks is a good insight. But Krugman is closer to identifying the financial crisis than Megan.

And if you look to my post on Mark Perry's accuracy he's critical of Krugman just prior to the crash for being doom and gloom.

HispanicPundit said...


Let me clarify. When I say, "Can you provide evidence for your "facts""...I mean, you know, actual links. Actual proof. Not more heresay.

I'll wait to respond when you actually, you know, provide proof.

Jon said...

It's all at the link you provided to my blog with Krugman talking about the housing bubble in 2006. Here's Megan disagreeing with Krugman's gloomy outlook in 2008. She's not too fatalistic. It's worth looking at the Krugman post Megan takes exception with. Krugman we now know was right on.

Here's Megan saying housing prices sound like tech stocks. That's coming from you by the way. As I said, I do give her credit for that. She saw we were in a bubble. She just didn't understand the implications. If she did she wouldn't have taken exception with Krugman's post above.

And in my prior comment I provided this link to Krugman in 2005 talking about how we're running out of bubbles, which have been the fuel that drove the economy and pulled it out of the recession (like Krugman said they would).

HispanicPundit said...

Here is McArdle in the link (I strongly encourage readers to read through the links and then read Jon's characterizations):

I think it's obvious we're in a slowdown, and a recession seems likely-ish, but Britain's skirted recession for over a decade now, so I can't be too fatalistic.

Think about the significance of this. While Krugman has been (falsely) predicting recessions, in this one instance, McArdle actually agrees with him - when, you know, we actually DID go into recession! So in this one instance, her accuracy is already better than Krugman's.

Now, you might say, she predicts recession guardingly - but read the Krugman post in question, he too predicts recession guardingly ("Those aren’t rhetorical questions. I’m actually not sure how bad things will get — remember, we still have help from booming exports.")

I should also add that as a long time reader of McArdle, I credit her with my decision to move almost all of my 401k to fixed income in early 2008. It was precisely her calls for a likley recession that pushed me to do so. It was such a good move that I actually MADE money in 2008 - while most of my friends lost between 40 and 60%.

Oh and, again, McArdle was stating that we were in a housing bubble LONG BEFORE Krugman was. In fact, in 2002 Krugman was advocating for a housing bubble - precisely at a time when McArdle was stating we were already in one.

I put that easily, 3-1 McArdle. But I encourage readers to read through the links and decide for themselves.

Jon said...

Why can't you just give Krugman some credit? I think you're just being way too partisan. I've given Megan some credit. You can't give Krugman a little credit?

Krugman's error, if you can call it that, is that he wasn't pessimistic enough. He talks about how unemployment could easily get higher than 6%. He's very worried. It was much worse than his worst expectations. And yet Megan thought he was going too far in his pessimism, as did Mark Perry. OK, he said it guardingly. Megan thought his guarded pessimism was going too far.

Megan was MORE POSITIVE than Krugman and we now know that Krugman was TOO POSITIVE. So Megan is more wrong than Krugman.

And here's another key point. Saying "I expect a recession" does not impress me. What Krugman did is he said "I expect a recession BECAUSE of the bubbling housing prices. These are the fuel of demand. Demand falls and so does our economy." That's maybe easy to grasp in retrospect, but not easy to predict. Megan says "Recession likely-ish." Why? She doesn't say. And she's replying to Krugman who just explained the reasons to her. She still doesn't grasp it. So I'm not impressed.

And by the way, you claimed Megan predicted a financial crisis, but you haven't given any evidence for that claim. You asked me for the evidence of my claims and I provided the links. Do you have a link or do you want to withdraw that claim?

HispanicPundit said...

Jon writes, Why can't you just give Krugman some credit?...You can't give Krugman a little credit?

This is what I wrote: I put that easily, 3-1 McArdle. That's giving Krugman SOME credit. Now if you want to argue that I should give Krugman MORE credit, fine, but I HAVE given him "a little" and "some" credit!

Regarding Krugman you write: He talks about how unemployment could easily get higher than 6%. He's very worried. It was much worse than his worst expectations.

This is from someone who (likely) was NOT reading Krugman in 2008. Who probably doesn't even know what "much worse than his worst expectations" is for Krugman. This is Jon intentionally adding what he HOPES to the thread, not what he knows. As a long time reader of Krugman, I can tell you - he has been constantly predicting recessions. It was as if everytime Republicans proposed a tax cut, he proposed a recession.

Take Jon's characterization that Krugman "talks about how unemployment could easily get higher than 6%". Well remember, unemployment in early 2008 was about 5%. So he isn't talking "much worse than his worst expectations", he is expecting a 1% higher unemployment rate, maybe more. This certainly isn't "much worse than his worst expectations", this is 'typical recession' talk. Hardly anything like what really happened.

Add in the guarding comment of "I’m actually not sure how bad things will get", and I think on intensity, it's a wash between Krugman and matter how much Jon wishes it isn't so.

Regarding McArdle and the recession. Again, I encourage readers to read her post. In it, she doesn't even touch on the INTENSITY of the recession, she touches on the PROBABILITY. If I had to summarize what she wrote it would be, "YES, this time I agree with Krugman that we are headed towards a recession, but remember, there have been times where a recession seemed likely and it didn't happen". Krugman, remember, also guardingly predicts a recession as I showed above.

You also write, And by the way, you claimed Megan predicted a financial crisis, but you haven't given any evidence for that claim. ... Do you have a link or do you want to withdraw that claim?

If you scroll up a few comments you will see that I wrote: Let me rewind: McArdle predicted the housing bubble LONG before Krugman...AND...had enough foresight to NOT recommend a housing bubble at the beginning of the housing bubble.

So yes, I withdraw that claim. Neither McArdle NOR Krugman predicted a financial crisis. :-)

So let me recap: Krugman does seem to predict a recession in early 2008. Kudos to him (1 point). McArdle TOO predicts a recession in early 2008. Kudos to her (1 point). McArdle also does NOT FALSELY predict recessions all of the previous times Krugman did. Kudos to her (1 point). McArdle also predicts a housing bubble, long before Krugman did. Kudos to her (1 point). McArdle also does NOT recommend a housing bubble right at the time where a housing bubble is already forming, like Krugman that wrecked havoc on the economy. Kudos to her (1 point).

So again, I put this: 4-1 McArdle. Looks like I was giving Krugman TOO MUCH credit previously. Keep this in mind when Jon admits, repeatedly, that he does not read McArdle but reads Krugman.

Jon said...

I think we're going around in circles on this, but for reference here's Krugman in 2002 calling the housing bubble. Seeing the bubble is a matter of looking at a plot of prices. That doesn't require a ton of insight. What matters to me is, do you understand the implications of the bubble. Krugman does and Megan doesn't.

Don't forget to score one for my cat. My cat didn't recommend a bubble to fuel demand either. My cat doesn't understand the implications of a bubble, so she's in no position to recommend anything. Are you impressed with my cat?

Jon said...

And by the way, I don't accept your assertion that Krugman constantly falsely predicts recessions. You need to link to it before scoring it. You should also recognize that Megan's so called prediction of a recession was her TAKING EXCEPTION to Krugman predicting a recession. He said recession coming. She straddled the line (likely-ish, but maybe not). That's not really predicting a recession. So your 4 points for McArdle are:

1-She identified the bubble in 2002 (so did Krugman).

2-She predicted a recession (I disagree, she straddled and said Krugman was too pessimistic, in fact he wasn't pessimistic enough, so she was quite wrong on this).

3-Krugman always predicts recessions and Megan doesn't (you provide no evidence for this).

4-She didn't recommend a bubble to spur demand (neither did my cat, she probably doesn't understand it well enough to make such a recommendation).

By the way, write to me, not to hypothetical readers. It's a bit annoying.

HispanicPundit said...

Jon writes: Don't forget to score one for my cat. My cat didn't recommend a bubble to fuel demand either.

Good point - so let me be clear, both McArdle AND your cat have a point above Krugman: remember, Krugman DID recommend a housing bubble at a time when there was already a housing bubble (and Krugman new about it!). In other words, I take Krugmans 2002 housing bubble recommendation as a point against him. If you disagree say so.

Krugman's not looking too good now, is he? Even your cat has a point above him!

You write:

Jon writes: You should also recognize that Megan's so called prediction of a recession was her TAKING EXCEPTION to Krugman predicting a recession.

This is where I disagree. Her post shows her GUARDINGLY (as Krugman did) agreeing with his post! It's an's saying, yeah he is right on THIS ONE (as opposed to the others). You disagree. Fine. I encourage the readers to read the link for themselves.

With your updated post, I give it 4-2 McArdle now.

HispanicPundit said...

Jon writes: 3-Krugman always predicts recessions and Megan doesn't (you provide no evidence for this).

Sorry, forgot to add the link. See here.

I guess if you shoot 10 darts and nine miss but one makes it, does that make you a pro? :-)

Jon said...

This is from ever the optimist Mark Perry blissfully unaware, like Megan, that in fact when they wrote this we were in a recession. Predictions 5-9 were all about the mother of all recessions that started at the end of 2007. They mock Krugman in order to give the impression that there's no problem. We're already in recession. Megan and Perry just don't know it.

If you read the links to the others he's not always talking about an official recession. In the first he says things like he's not necessarily saying there will be the kind of drop in GDP that officially qualifies as a recession. He's talking about suffering amongst people with stagnant wages, people giving up looking for jobs, etc. In fact this is what happened in the 2000's. A rather unprecedented faltering in median wages and also wages for lower income groups. The kinds of consequences he's predicting for the Bush tax cuts have pretty much been born out. I don't know what else you want.

So he's mostly right even at your own critical link. 5 of them are about Perry and Megan being wrong but they just don't know it yet. If that's the best you got it's looking grim.

HispanicPundit said...

It's a quick google search. I don't have the time to do something exhaustive. I think most people who have read Krugman for a long time would agree with the overall general characterization - constant doom and gloom (which is why McArdle doesn't post link after link, its kinda an obvious statement).

I still stand by my 4-2 McArdle though.