idea that fraud and reckless lending flourished because US financial markets were unable to honestly and efficiently intermediate

TO BE FILED: From Vox:

"Global imbalances and the crisis: A solution in search of a problem

Michael Dooley Peter Garber 21 March 2009

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This column argues that current account imbalances, easy US monetary policy, and financial innovation are not the causes to blame for the global crisis. It says that attacking Bretton Woods II as a major cause of the crisis is an attack on the world trading system and a sure way to metastasise the crisis in the global financial system into a crisis of the global economic system.

The current crisis is likely to be one of the most costly in our history, and the desire to reform the system so that it will not happen again is overwhelming. Our fear is that almost all this effort will be misdirected and unnecessarily costly. Three important misconceptions could lead to a disastrous reform agenda:

1. That the crisis was caused by current account imbalances, particularly by net flows of savings from emerging markets to the US.
2. That the crisis was caused by easy monetary policy in the US.
3. That the crisis was caused by financial innovation.

In our view, a far more plausible argument is that the crisis was caused by ineffective supervision and regulation of financial markets in the US and other industrial countries driven by ill-conceived policy choices. The important implication of the crisis itself is that for the next few years, at least, the misbehaviour that flourished in this environment will not be a problem, unless replicated under government pressure to restore the flow of credit to the uncreditworthy. If anything, excessive risk aversion and deleveraging will limit effective private financial intermediation. So the first precept for reform is that there is no hurry.

When markets recover, the key lesson is that the industrial countries need to focus on moral hazard, public and private, as the source of the problem and apply the prudential regulations they already have to financial entities that are too large to fail. It is not sensible to try to limit international trade and capital flows, to ask central banks to abandon inflation targeting, to stifle financial innovation, or to regulate entities such as hedge funds¹ that do not generate systemic risks.

International capital flows

One “lesson” that seems to be emerging is that international capital flows associated with current account imbalances were a cause of the crisis and therefore must be eliminated or at least greatly reduced.² The idea that fraud and reckless lending flourished because US financial markets were unable to honestly and efficiently intermediate a net flow of foreign savings equal to about 5% of GDP, while having no problem with intermediating much larger flows of domestic savings, is astonishing to us. If so, would not the much larger gross capital flows into and out of the US also cause an outbreak of bad behaviour even without a net imbalance? If this were true, we would have to stop all capital flows, not just net imbalances. In the US context, we are unable to think of any plausible model for such behaviour.

If capital inflows did not directly cause the crisis perhaps they did so indirectly by depressing real interest rates in the US and other industrial countries. We have emphasised that capital inflows to the US from emerging markets associated with managed exchange rates caused persistently low long-term real interest rates in both the US and generally throughout the industrial world (Dooley, Folkerts-Landau and Garber 2004, 2009). Low real interest rates in turn drove asset prices up, particularly for long-duration assets such as equity and real estate.³ At the same time, low real interest rates temporarily reduced credit risks and a stable economic environment generated a marked decline in volatility of asset prices.

We have not argued that a “savings glut” in emerging markets is the fundamental driving force behind these capital flows. We have argued that the decisions of governments of emerging markets to place an unusually large share of domestic savings in US assets depressed real interest rates in the US and elsewhere in financial markets closely integrated with the US. These official capital flows are not offset, but reinforced, by private capital flows because managed exchange rate pegs are credible for China and other Asian emerging markets.

Low risk-free real interest rates that were expected to persist for a long time, in the absence of a downturn, generated equilibrium asset prices that appeared high by historical standards. These equilibrium prices looked like bubbles to those who expected real interest rates and asset prices to return to historical norms in the near future.

Along with our critics, we recognised that if we were wrong about the durability of the Bretton Woods II system and the associated durability of low real interest rates, the decline in asset prices would be spectacular and very negative for financial stability and economic activity. The hard landing predicted for Bretton Woods II was not to be caused by low real interest rates per se but by the sudden end to low interest rates as unsustainable capital inflows to the US were reversed. This is not the crisis that actually hit the global system.

But the idea that an excessive compression of spreads and increased leverage were directly caused by low real interest rates seems to us entirely without foundation.⁴ The alternative hypothesis is that an effective deregulation of US markets driven by government-dictated social policy, especially in mortgage origination and packaging, allowed the ever-present incentive to exploit moral hazard to flourish.⁵ This could just as well have happened with stable or rising real interest rates, as it did, for example, during the lead up to the US S&L crisis in the 1980s, another government manufactured disaster. Falling real interest rates in themselves should make a financial system more stable and an economy more productive.

Imagine a global system with permanent 4% equilibrium real interest rates. Now imagine a system with permanent 2% real interest rates. Why is one obviously more prone to fraud and speculation than the other? The vague assumption seems to be that capital inflows were large and interest rates were low, and this encouraged “bad” behaviour.

The current conventional interpretation is that low interest rates and rising asset prices generated an environment in which reckless and even dishonest financial transactions flourished. One version of this story is that rising real estate prices led naïve investors to believe that prices would always rise so that households with little income or assets could always pay for a house with capital gains on that house. Moreover, households could borrow against these expected capital gains to maintain current consumption at artificially high levels. This pure bubble idea does not provide much guidance for reforming the international monetary system. Clearly we should enforce prudential regulations that discourage people from acting on such expectations. But do we really want to reform away anything that causes real interest rates to fall and asset prices to rise?

Easy money and financial innovation

There is no sensible economic model that suggests that monetary policy can depress or elevate real long-term interest rates. The Fed could in theory target nominal asset prices (for example equity prices), but it would then lose control over the CPI. Would Alan Greenspan’s critics have preferred a monetary contraction necessary to depress the CPI enough to allow the real value of equities to rise? The Fed could, and may still, inflate away the real value of financial assets but this requires inflation as conventionally measured. This may yet come, but it was not a part of the story in recent years, and it is still not expected by market participants.

Third in the roundup of usual suspects in the blame game is financial innovation. There is no doubt that innovation has dramatically altered the incentives of financial institutions and other market participants in recent years. Securitisation of mortgages, for example, clearly reduces the incentives for those that originate credits to carefully screen applications. But securitisation also reduced the cost of mortgage credit and increased the value of housing as collateral. Private equity facilitated the dismantling of inefficient corporate structures. Venture capital has directed capital to high-risk but high-reward activities. Before we give up these benefits we need to ask if it is possible to retain the advantages of these innovations without the costs associated with the current crisis.

The problem was not financial innovation but the failure of regulators to recognise that innovation generated new ways to exploit moral hazard. Even more, it was the wilful ignorance of policymakers in often overriding the instincts of regulators and financial institutions in order to implement a desired flow of funds to uncreditworthy borrowers.

Fraud is not a financial innovation. The unhappy fact is that any change in the financial environment can generate new ways to undertake dishonest and imprudent positions. The regulators in turn have to adapt their procedures for monitoring and discouraging such activities. If it is really the case that regulators cannot understand the risks associated with modern financial markets and instruments, then there is a strong case for trying to return to a simple and relatively inefficient system. But we do not believe the story that no one can understand these innovations. To the contrary, it seems clear to us that the bankers that used these innovations to exploit moral hazard knew very well what they were doing and why. The first-best response to this is to attract a few of the many quants who are now unemployed to help enforce the prudential regulations already on the books.

Conclusions

In this crisis, three macro-financial institutional arrangements remain to hold the financial system together. These are the dollar as the key reserve currency with US Treasury securities as the ultimate safe haven, the integrity of the euro, and the global monetary system as defined by the Bretton Woods II view. Attacking the latter as a major cause of the crisis and seeking its end is, at the end of the day, an attack on the basis of the international trading system. It is a sure way to metastasise the crisis in the global financial system further into a crisis of the global economic system.

References

Bernanke, Ben (2007) “Global Imbalances: Recent Developments and Prospects" speech delivered at Bundesbank Berlin September 11.
BIS 78^th Annual Report (2008).
Dooley, Michael P., David Folkerts-Landau and Peter M. Garber (2004) “The Revived Bretton Woods System,” International Journal of Finance and Economics, 9:307-313.
Dooley, Michael P., David Folkerts-Landau and Peter M. Garber (2009) “Bretton Woods II Still Defines the International Monetary System,” NBER Working Paper 14731 (February).
Dunaway, Steven, Global Imbalances and Financial Crisis, Council for Foreign Relations Press, March, 2009.
Economic Report of the President (2008)
Economist (2009) When a Flow Becomes a Flood,” January 22.
Paulson, Henry (2008) “Remarks by Secretary Henry M. Paulson, Jr., on the Financial Rescue Package and Economic Update,” U.S. Treasury press release, November 12.
Sester, Brad (2008) “Bretton Woods 2 and the Current Crisis: Any Link?", Council on Foreign Relations

Notes

1. Of course, a bank thinly disguised as a hedge fund should be regulated as a bank just as a hedge fund thinly disguised as a bank should be.
2. See Paulson (2008), Dunaway (2009).
3. This is arithmetic, not economics. A permanent fifty percent decline in the level of real interest rates, for example from 4% to 2%, is the same thing as a doubling of an infinite maturity financial asset’s price, provided that the payout from that asset is unchanged. For practical purposes, thirty years is good enough to about double prices.
4. This view has taken hold in central banks see Bernanke (2007), Hunt (2008), BIS (2008). In the financial press, see Sester (2008) and Economist (2009). It should be noted for the record that these claims are always raw assertions, without theoretical, empirical, or even logical basis.
5. The financial system problems in many other countries are independent of regulatory problems in the US. The banking collapses in Iceland, the UK, and Ireland were home grown. The loans of the European banking system to Eastern Europe and to emerging markets in general were independent of US financial system behavior.

driven down saving yields

From News N Economics:

"Fed measures killed the yield on household saving

Saturday, April 25, 2009

A reader of this blog expressed concern about the effects of the Fed's massive expansionary efforts on the value of household saving. Specifically, the Fed slashed its fed funds target 510 bps from 5.25% in September 2007 to 0%-0.25% in December 2008, which has likewise driven down saving yields. Tom Petruno at the LA Times wrote a piece to this effect:

Who's really bailing out the banks?

Taxpayers, for sure. But the largely unsung victims of the financial system rescue are loyal bank depositors -- especially older people who have relied on interest income from savings certificates to live.

To save the banks from soaring loan losses, the Federal Reserve did what it always does when the industry gets into trouble: Policymakers hacked their benchmark short-term interest rate, which in turn pulled down all other short-term rates, including on savings vehicles.

But this time the Fed went to rock-bottom on rates. In December, the central bank declared that it would allow its benchmark rate to fall as low as zero.

Savers still are paying the price for that gift to the banks. Average rates on certificates of deposit nationwide have continued to slide this year, according to rate tracker Informa Research Services in Calabasas.

The average yield on a six-month CD fell to 1.27% this week, down from 1.86% on Jan. 1 and 2.24% a year ago. Anyone who has a CD maturing soon should be prepared for serious sticker shock.

Banks have been able to continue whittling down savings yields because the industry overall is flush with cash -- not just from the Fed's efforts to pump unprecedented sums into the financial system, but also because the events of the last year have left many people too afraid to keep their money in anything but a federally insured bank account. At least you know your principal is guaranteed.

Even as short-term interest rates have dived since the financial crisis exploded in September, the total sum in CDs under $100,000, as well as savings deposits and checking accounts, has soared by $507 billion, to $6.07 trillion, according to data compiled by the Fed.

RW: In spite of the rock bottom rates on saving accounts, CDs, and money market mutual funds, households continue to flock to the safety of these insured funds. And in response to increasing demand for saving instruments - the personal saving rate rose from 0.3% in February 2008 to 4.2% one year later - banks will draw down yields further.

Buy what Tom doesn't' say is that rock-bottom rates are here to stay. According to the FOMC statement:

"economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

And how long is that? Well, recently the Bank of Canada, whose interest rate policy tends to move in sync with the Fed's, released its monetary policy statmement. The BoC cut its overnight rate target to 0.25%; but more importantly, it made a definitive statement of how long might be an extended period:

"Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target."

It looks like saving rates will be low for a while, folks. The massive economic contraction is dragging down prices, and the IMF is forecasting U.S. deflation throughout 2010 (see Table A5 in the World Economic Update). Using the BoC's statement as a proxy for extended period, the near-zero federal funds target will hold saving yields low until June 2010, fourteen more months from now.

Disclaimer: To me, deflation remains to be a mechanism to clear markets rather than a macroeconomic hindrance. And furthermore, the IMF's outlook is very gloomy. Clearly, with 0% growth in 2010 for both the U.S. and the sum of advanced economies, the IMF expects an onslaught of defaults that are already in the pipeline, defaults that are not currently priced into market activity. We will see, though. The World Bank is projecting 2% U.S. growth in 2010.

Rebecca Wilder"

Me:

Don said...

"It looks like saving rates will be low for a while, folks."

I hate to be the person always sounding paradoxical, but the response from people that we want is to for them to find the low rates unacceptable and to start to go looking for riskier and higher yielding investments. That's how you conquer the fear and aversion to risk.

The added risk is, in fact, investment in forward looking projects that are unusually scary in a downturn. Presumably, that's the rationale for government investing during a downturn. Those of us who like private investment better than government would prefer individuals to start accepting more risk in investment.

Since many businesses don't make it, investing under our system is always risky. That's why we need risk. I'm not an investor, but I'd look into corporate bonds.

Don the libertarian Democrat

April 25, 2009 11:54 AM"

sign that low interest rates may be moderating declines in real estate values

TO BE NOTED: From Bloomberg:

"Home Prices Gain 0.7% in February From January (Update1)

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By Kathleen M. Howley

April 22 (Bloomberg) -- U.S. home prices rose 0.7 percent in February from January, the first consecutive monthly gain in two years, a sign that low interest rates may be moderating declines in real estate values.

Prices fell 6.5 percent in February from a year earlier, the second-smallest drop in six months, led by a 19 percent decrease in the region that includes California, the most populous U.S. state, the Federal Housing Finance Agency in Washington said today. The gain in February from a month earlier beat the average estimate of 10 analysts in a Bloomberg survey for a decline of 0.7 percent.

Mortgage rates have tumbled 1.6 percentage points in six months, making houses and condominiums more affordable. The Mortgage Bankers Association’s index of applications to purchase a home or refinance a loan increased 5.3 percent last week as Americans took advantage of interest rates near record lows. Home sales rose 5.1 percent in February from a month earlier, the National Association of Realtors said March 23.

“As demand firms, and once inventories of houses and a broad range of goods are brought into line with sales, economic activity should begin to stabilize,” Federal Reserve Vice Chairman Donald Kohn said in an April 20 speech in Delaware.

The inventory of properties on the market fell to a 9.7 month supply in February at the current sales pace, down from April’s high of 11.3 months, and sales rose 5.1 percent from a month earlier, the Realtors group said.

The number of Americans signing contracts to buy previously owned homes rose 2.1 percent in February, led by a 14.5 percent jump in the Midwest and a 10.6 percent increase in the Northeast, the National Association of Realtors said in an April 1 report.

Arizona, Nevada

The FHFA’s February house price index is down 9.5 percent from its peak in April 2007. The Mountain region of the U.S., including Arizona and Nevada, had the second-biggest decline in home prices from a year ago, dropping 9.2 percent, the FHFA said in today’s report. The South Atlantic area, including Florida, fell 8 percent.

New York, New Jersey and Pennsylvania declined 4.1 percent from a year earlier and New England dropped 3 percent, according to the report.

Mortgage Rates

The average U.S. rate for a 30-year fixed home loan dropped to 4.82 percent last week from 4.87 percent a week earlier, according to Freddie Mac, the McLean, Virginia-based mortgage buyer. The rate has averaged 5.02 percent this year, compared with 6.21 percent during the five-year housing boom that ended in 2005.

The difference between 30-year mortgage rates and 10-year Treasury yields has narrowed to about 2.2 percent from 3.1 percent in December, which was the widest since 1986. The spread remains almost 0.7 percentage point above the average of the past decade, data compiled by Bloomberg show. Rates for 15-year mortgages are about 1.8 percent above 10-year Treasury yields, compared with an average 1.4 percent since 1999.

U.S. banks owned $11.5 billion of foreclosed homes in the fourth quarter, up from $6.7 billion a year earlier, according to the Federal Deposit Insurance Corp. in Washington. California and Florida metropolitan areas led the U.S. in foreclosures in the first quarter as unemployment and falling property values deepened the housing recession, according to RealtyTrac Inc., based in Irvine, California.

‘Glut of Homes’

“Whatever damage has been done in California is only going to get worse because there is a glut of homes owned by lenders that aren’t yet on the market,” said Bruce Norris, a principal with the Norris Group, a Riverside, California-based real estate investment firm. “These homes are like a shadow inventory that is likely to drag down prices further when they come onto the market.”

Freddie Mac, along with larger rival, Washington-based Fannie Mae and banks including New York-based Citigroup Inc., have slowed or delayed foreclosures using various moratorium plans in the hopes that homeowners in default will be able to modify their loans.

U.S. home prices probably will fall 5.1 percent this year to $188,500, less than the 9.3 percent plunge in 2008, according to the real estate group. Home resales probably will rise 1 percent to 4.96 million after a 13 percent drop last year, NAR said in a forecast posted on its Web site.

The housing market may be buoyed by improvements in the banking sector. Treasury Secretary Timothy Geithner said yesterday in testimony to a congressional oversight panel that most banks now have “more capital than they need.” Geithner also said there were signs of “thawing” in credit markets.

The U.S. has pumped more than $590 billion of public money into troubled financial institutions over the last six months through the $700 billion Troubled Asset Relief Program. Geithner said in a letter to the oversight committee yesterday that $109.6 billion remains of the funds authorized by the Emergency Economic Stabilization Act last year.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net."

"The dollar's fall, however, is making it far harder for Europe and Japan in particular to export their way out of recession. "

I posted a graph showing the recent rise and decline of the dollar. From the Washington Post:

"By Anthony Faiola

Washington Post Staff Writer
Thursday, December 18, 2008; Page A01

The dollar yesterday staged one of its biggest one-day drops against the euro and fell to a 13-year low against the Japanese yen as near-zero interest rates and the Federal Reserve's plan to print vast sums of cash dilute the value of the greenback.( Quantitative Easing )

The drops dramatically accelerated the dollar's reversal of fortune over the past three weeks after months of solid gains( THE FLIGHT TO SAFETY IN US BONDS ). The slide underscores the risks the Federal Reserve is taking to jump-start the U.S. economy through aggressive monetary policy( THERE ARE RISKS ).

On Monday, the Fed cut its target for the federal funds rate, at which banks lend to each other, from 1 percent to a target range of 0 percent to 0.25 percent, and effectively vowed to print as much money as it needs to try to pull the United States from a worsening recession ( I'M FOR THIS ).

While that policy may ultimately aid an economic recovery, it is robbing the dollar of value as investors anticipate less interest on their dollar-denominated investments and more bills in circulation, making each one worth a bit less. In response, investors are dumping the dollar and buying up other currencies ( I PREFER TO SAY THAT IF THEY BUY BONDS NOW, AND INFLATION ARISES, THEIR BONDS WILL BE WORTH LESS. ON THE OTHER HAND, SINCE THERE WILL BE MORE DOLLARS IN CIRCULATION, THE DOLLARS THEY ARE HOLDING NOW WILL BE WORTH LESS ( FROM QUANTITATIVE EASING ) ).

If the dollar's fall is unchecked, it could jeopardize the long-term faith of foreign investors in the value of the American currency and could cause foreign investors to dump U.S. stocks and other assets, whose value would be worth less in euros or yen( TRUE ). The Dow Jones industrial average fell 1.1 percent yesterday.

A sharp rise in the value of foreign currencies could slow economic recovery in Europe and Japan because it would make their exports more expensive in the United States ( TRUE ). A steep, sustained fall in the dollar could force the Fed to abruptly raise interest rates to prop it up( IN ORDER TO GIVE INVESTORS AN INCENTIVE TO BUY BONDS BECAUSE OF THE HIGHER INTEREST RATES, AND THEIR DOLLARS WOULD GAIN IN VALUE IF THE MONEY SUPPLY CONTRACTS ). That would drive up costs( BECAUSE IT WOULD BE PAYING MORE INTEREST ) for the U.S. Treasury as it seeks to raise cash for bailouts by issuing billions of dollars worth of new debt to investors.

"The risk is that the deceleration of the dollar could cascade, and push interest rates up as the rest of the world demands a higher return on U.S. investments," said C. Fred Bergsten, director of the Peterson Institute for International Economics.

But higher interest rates could weaken demand even more. The deteriorating economic outlook helped send oil prices down yesterday to $40.06 on the New York Mercantile Exchange, despite production cuts by the Organization of the Petroleum Exporting Countries, and the falling dollar, which should help drive up oil prices because they are denominated in dollars( AND SO WORTH LESS ).

The dollar shed about 3 percent against the euro yesterday, falling to $1.44. It lost 1.3 percent against the Japanese yen, dropping to 87.93, the lowest since July 1995.

The slide marks another turn on the dollar's roller coaster year, which it began at multiyear lows when the U.S. economy slowed even as much of the rest of world was still growing. But as investors began to grasp that Europe and Japan were facing recessions as bad, if not worse, than the one in the United States, the dollar staged a rally. Between July and November, the dollar climbed about 24 percent against a basket of six major world currencies( MAINLY THE FLIGHT TO SAFETY ).

The Fed's aggressive interest rate policy ( QUANTITATIVE EASING ), coupled with a sense that the United States may face dire problems in the auto industry( MORE EASING AND DEBT ), have erased about half those gains in the past three weeks. Up until recently, emerging market currencies were also losing ground against the dollar. The Chinese, analysts say, have been massively intervening in currency markets in recent months to weaken( KEEP IT CHEAP ) the yuan and make Chinese exports more competitive overseas( BY STAYING CHEAP ). But the yuan has jumped 0.7 percent against the dollar this month, despite continued Chinese intervention.

That is good news for U.S. exporters ( OUR GOODS ARE CHEAPER ). The cheaper dollar earlier this year had boosted overseas sales of American-made products from airplanes to soybeans, making exports a rare bright spot of the economy. In recent months, however, the export boom has faded as the dollar strengthened and the global economy waned. The suddenly weaker dollar may now help put U.S. exports back on track, just when the economy needs all the help it can get ( THEORETICALLY, EXPORTS SHOULD GO UP WITH A CHEAPER DOLLAR, AND, AT SOME POINT, AS THE ECONOMY DOES BETTER, THE DOLLAR WILL STABILIZE OR TURN AROUND ).

The dollar's fall, however, is making it far harder for Europe and Japan in particular to export their way out of recession ( THEIR GOODS ARE GETTING MORE EXPENSIVE FOR US ).

Japan, which already has near-zero interest rates, has little room to lower them further to weaken the yen. But analysts say Tokyo is likely buy more dollars ( THAT SHOULD STRENGTHEN THE DOLLAR, MAKE THE YEN CHEAPER ) in an attempt to drive the yen down in value.

The dollar's fall is putting particular pressure on the European Central Bank to follow the Federal Reserve and the Bank of Japan and dramatically cut interest rates ( WITH THEIR HIGHER INTEREST RATES AND RETURN, MONEY IS GOING THERE AND NOT TO THE DOLLAR ), according to analysts. The ECB has been reluctant to slash rates too deeply, partly because it fears that inflation will reemerge in major countries like France( THIS SHOULD BE EXPLAINED ) should rates fall too low.

Yet analysts say the weakened dollar may force the ECB to cut rates, fearing the steep climb in the euro could make it far harder for export-driven economies like Germany to stage a recovery. Some in Europe are responding aggressively. The Central Bank in Norway, which does not use the euro, dramatically slashed key interest rates yesterday by 1.75 percent to 3 percent.

"This really puts the Europeans in a corner," said Simon Johnson, former chief economist at the International Monetary Fund and an economist at the Massachusetts Institute of Technology. "They can't just sit there and watch the euro climb( EXPORTS WILL GO DOWN, HURTING THEIR ECONOMY )."

Other analysts argue that the dollar may surge again in the weeks ahead, particularly if the Fed's aggressive moves begin to show signs of lifting the U.S. economy ( IF QUANTITATIVE EASING WORKS ).

"I'm a little skeptical that this is the end of the dollar's rebound," said John Shin, currency strategist at Merrill Lynch in New York. "Investors are reacting to the anticipation and the actuality of the Fed's plan to flood the world with dollars. But the U.S. is not alone in its problems, and you're seeing particular stress on the European economy. You have to think that the Fed is ahead of the curve, and by the time the Europeans get there, the U.S. economy may be better positioned for recovery( OTHER COUNTRIES WILL END UP DOING WHAT WE'RE DOING, GIVING THEM NO COMPETITIVE ADVANTAGE WITH HIGHER INTEREST RATES, GIVING THE DOLLAR STRENGTH AGAINST THE OTHER CURRENCIES )."

The Dollar's steep rise was the Flight To Safety, the steep decline is Fear Of Inflation. Both are likely overreactions to actual conditions. I hope.

"As an investor or trader , you have to perform due diligence not on just trades or investments, but also on your broker or prop firm, your bank,...

I posted that you cannot just trust Banks because they have Low-Information Assets. You must study and examine every place that you invest or put your money. Here's the Trader's Narrative:

"Due diligence has many meanings depending on context. If you pressed me for a definition within finance, I would say it is:

The process of investigation undertaken by an party to gather material information on actual or potential risks involved in a financial transaction or relationship. ( I AGREE, AND WILL KEEP THIS AS "TRADER'S NARRATIVE'S DUE DILIGENCE )

If you suffered losses as a result of Madoff’s fraud, then this lesson is extremely expensive. If not, it is probably the biggest gift Madoff has given the world.

As an investor or trader

, you have to perform due diligence not on just trades or investments, but also on your broker or prop firm, your bank, your accountant, etc. Each link in the chain is vital. Never assume anything. Check and verify every little detail. As this most recent event has shown beyond a shadow of a doubt, you have to take personal responsibility and can not have the SEC or FBI do it for you."

Please note this point well.

"Madoff’s Ponzi scheme has snared not just wealthy individuals but very large instititutions like Nomura, BNP Paribas, Neue Privat Bank, Santander, UniCredit, Lombard Odier, Royal Bank of Scotland

as well as dozens and dozens of fund of funds that allocated portions of their assets under management to Madoff. These institutions supposedly have whole departments full of lawyers and accountants who are given the task of due diligence. Each and everyone of them failed their fiduciary responsibility and will probably be sued by those who experienced losses."

I hope that this occurs. It's absolutely necessary in order to try and avoid this happening again.

"Just out of curiosity, I looked the website for Optimal Investment Services, the hedge fund

arm of Banco Santander. Here is a snippet:

Optimal clients were exposed to the tune of 2.33 billion euros or $3 billion US dollars, according to a report from Bloomberg.

What sort of due diligence did they perform exactly? one that didn’t flag a potential problem with Madoff being the broker, custodian and investment manager, all rolled into one? one which missed the fact that a tiny one person accounting firm did their annual audit?

A lot of heads in “due diligence” and “risk management” departments are going to roll."

Maybe Hempton could do it.

"how do we explain an increase in optimism? "

Here's another take by Lawrence H. White on Casey Mulligan's notion of Optimism causing the Housing Bubble:

"If I understand him rightly, I don’t much disagree with Professor Mulligan. We agree that Federal Reserve policy acted to promote the housing price boom by lowering real interest rates. The difficult question is: what share of the boom can we attribute to monetary policy, and what share to other independent sources? Applying Professor Mulligan’s way of computing the impact of lower real interest rates alone on the present discounted values of houses, correct anticipation in 2002 of real T-bill rates — which were about to go 200 basis points lower for the next three years — can account for only around a six percent rise in house prices. Thus the milder-discounting effect by itself accounts for only a fraction of the actual run-up in prices observed, assuming correct anticipations. The present-value calculation is straightforward.

We can get a bit more impact out of lower interest rates by noting that the lowering of mortgage lending standards implied an even larger drop in risk-adjusted mortgage rates than in risk-free Treasury rates. Market participants did not have any clear basis in historical time series for anticipating that this drop would reverse itself soon.

Still, I agree that the joint hypothesis “real interest rate anticipations were correct and they alone fully explain the rise in house prices” is untenable. Of course, we already knew that anticipations of house prices could not have been correct, given that nobody would pay $300,000 for a house in 2006 that he knew would be worth only $200,000 two years later. "

I agree with this. No Spigot Theory.

"Professor Mulligan reasonably proposes to attribute the bulk of the rise in house prices to some kind of ex-post-mistaken (but not necessarily irrationally exuberant) anticipations, offering the hypothesis that “it was optimism that raised housing prices, not much of anything tangible during the boom. Whether it was optimism about future interest rates, future tastes, or future technology is more of a quibble.” Optimism about “tastes” here includes optimism about the future growth of demand in particular local housing markets. Something like that would seem to be required to explain why the house price boom was so highly concentrated in a few states. We can’t explain such concentration by appealing only to optimism about technology or national economic policy variables.

An appeal to optimism, of course, doesn’t really explain events but simply gives us a reframed question: how do we explain an increase in optimism? I suggest that optimism (regarding whatever) during this period was not independent of the rising rate of aggregate nominal income growth that was being fueled by Fed policy. Expansionary monetary policy may have (at least cyclically) effects on relative prices and real variables, like the real demand for houses, through income channels, not only through its effect on the real interest rate. I anticipate, and agree, with Professor Mulligan’s likely response that more needs to be done to quantify these other effects."

There seems good reason to believe that their was such an overabundance and overly magnified aspect of Wishful Thinking in this current situation. However, for the explanation, we need to understand the presuppositions, assumptions, and context of this explosion of Wishful Thinking. I believe that a lot of it comes down to an overestimation of what government can do, and simply thinking of the actors in this drama as free market adherents misses the true nature and assumptions of their belief system, which includes plenty of government intervention when it's in their interest.

"that it was optimism that raised housing prices, not much of anything tangible during the boom."

I often find myself agreeing with Casey Mulligan, although I'm not sure why. But once again, I agree with his basic point:

"Professor White showed that one-year real interest rates were low during the housing boom. That’s a good starting point because, if the Fed can affect anything real, it is the short-term interest rate. Now let’s use that information to demonstrate that the impact on housing prices is minimal.

Since I will demonstrate that the housing-price impact is small, I will assume that the supply of housing is fixed; an elastic supply of housing would only reduce the price impact below what I calculate here.

Each house in place today produces services for a number of years. To a good approximation, we can assume that each house lasts forever, except that it depreciates exponentially (but slowly). The market value of the house is the present value of those services. Low interest rates can raise housing prices (although not much), because future services are discounted less.

Suppose that annual real interest rates were going to be one percentage point (100 basis points) lower for a year. Then the cost of buying a house, holding it for a year, and then selling it would be essentially one percent less. The low one-year interest rate would not affect the selling price at the end of the year because, by assumption, the reduction lasted only for a year and the next buyer will be back to normal interest rates. So the source of benefit from the low rate is that the initial buyer reduces the carrying cost for a year.

A 100-basis-point-lower interest rate for one year would justify paying about $202,000 for a house that would ultimately be worth $200,000. A 100-basis-point-lower interest rate for two years would raise purchase prices by about two percent. (Actually, it would be less, because of the discounting of the second year, not to mention the supply response.) A 200-basis-point reduction for two years would raise purchase prices by less than four percent, etc.

Thus, interest-rate reductions for a short horizon do raise housing prices, but not much by the standards of this recent housing boom when housing prices were tens of percentage points higher (according to Case-Shiller, practically 100 percent higher). A house that would ultimately be worth $200,000 was actually selling for something in the neighborhood of $300,000.

Perhaps Professor White would argue that market participants expected short term interest rates to remain low for much longer than a couple of years. If so, he is on shaky ground. First, such a claim is at odds with long-term interest-rate data. As I indicated in my article, long-term mortgage rates were not low during the housing boom. It’s not hard to find commentary from those years recognizing the low short-term rates were not expected to last."

I agree with this. The low interest rates do not explain this crisis. At best, they are a necessary condition.

"Second, such a claim gets closer to my hypothesis: that it was optimism that raised housing prices, not much of anything tangible during the boom. Whether it was optimism about future interest rates, future tastes, or future technology is more of a quibble."

What does optimism mean?

1.	a disposition or tendency to look on the more favorable side of events or conditions and to expect the most favorable outcome.

2.	the belief that good ultimately predominates over evil in the world.

3.	the belief that goodness pervades reality.

4.	the doctrine that the existing world is the best of all possible worlds.

It would seem that it is 1 that he means. The most favorable outcome in:
1) Interest Rates
2) Future Tastes
3) Future Technology

I prefer "wishful thinking":

interpretation of facts, actions, words, etc., as one would like them to be rather than as they really are; imagining as actual what is not.

I prefer this phrase because I believe that people knew that they were taking risks, but chose to ignore them. There was a real disposition to ignore reality and history and even common sense.I'm not quite sure that they were optimistic. There was too much uncertainty in the world and too little faith in the Bush Administration for optimism. I hope that I'm making the difference clear.

I believe that much of this malady has to do with a general belief in the incompetence of the Bush Administration. So, my views, they don't qualify as a theory, predict that there will be a major change in the perception of our situation after we have left President Bush behind. The swearing in of President Obama should lead to more optimism, if you will, than we see now. I don't like how many predictions I've given on this blog. Perhaps it's time to sign off.

"The sooner prices are allowed to naturally fall to normal, post-bubble levels, and the sooner that houses become affordable"

I said that there were people who felt that the Fed's plan to help people buy houses was a mistake. Declan McCullagh on CBS News is one of them:

"In reality, more government intervention will do more harm than good. The sooner prices are allowed to naturally fall to normal, post-bubble levels, and the sooner that houses become affordable, the sooner the economy can heal itself and start growing instead of contracting.

By way of analogy, imagine a reprise of the Dutch tulip mania of 1637. Say the price of tulip bulbs has grown handsomely in the last few years, and impressive fortunes were made by early speculators.

Bidding wars erupt, with the winners hoping to resell them the bulbs at a handsome profit months or years later. Cable TV hosts proclaim that a golden age of prosperity has dawned. Prized bulbs change hands for $1 million each, and skeptics are reviled as doomsayers.

Eventually this boom leads to a bust, as new buyers become scarce, and the price of tulip bulbs suffers a dizzying fall down to $10 each. Speculators complain to Congress. Politicians pledge to use tax dollars to purchase bulbs for $1,000 or $10,000, invoking phrases like "stability" and "liquidity crisis," or offering taxpayer-backed loan guarantees to speculators.

This would sound silly for tulips, but it's close to what's happening for houses. All this will do is slow -- and not arrest -- the process of prices falling. Not even the president of the United States can veto the laws of supply and demand.

It's difficult to convince someone to buy a tulip bulb (or house) today if he thinks the price will be a lot lower in a year. Worse, government spending diverts funds away from productive purposes, including investment, education, and infrastructure. "

In general, I agree with this. But, there's one problem with this comment. It assumes that the people buying houses now won't be able to make their payments going forward. But what if they can? What if the problem isn't that current home purchasers are going to get into trouble, and banks aren't lending to them because of that. Rather, many people who can clearly afford the houses they are going to buy are being turned down because of the situation of the banks, which is being locked into a shell-shocked aversion to risk, and using money to clean up their books? How would you know?

"By usual metrics, such as the ratio of prices to incomes, the ratio of rents to mortgages, and the ratio of current prices to expected ones, some areas of the country still look pretty bubbly.

In the decade ending August 2008, according to S&P Case-Shiller data, house prices in New York metropolitan area leaped by 2.2 times, though incomes grew only modestly. The Washington, D.C. area experienced a 2.1-fold jump -- while non-bubbly areas like Cleveland saw an increase of a mere 1.17 times, which is consistent with incomes and inflation.

The median family income in Allentown, Penn. is $46,400, and the median home price is $125,000, meaning houses tend to cost 2.7x the median income. Compare that to San Francisco, where homes consume a whopping 11.6x the median annual salary. "

What if the usual metrics are wrong? They are failing to figure in demographic changes, regulation changes, wealthier people moving and concentrating in new areas where they drive up the prices,etc.? The real world metric is simply whether or not people can afford their houses. Is that metric written in stone?

"Robert Shiller, who teaches economics at Yale University, has calculated that housing prices have remained remarkably constant from 1890 through 1998, rising only 13 percent when adjusted for inflation -- through world wars, the automobile, and the rise of the two-income family. When the dot-com bubble burst, money flowed into real estate, encouraged by the Federal Reserve cutting interest rates more than prudence allowed. "

The Spigot Theory again. What does "more than prudence allowed" mean? Let's say it made it easier to fund a mortgage. Did that automatically lead to irrational and asinine lending practices?
What's the connection between low interests rates and fraud and stupidity? Is there a law for that? I'm trying to understand this phenomenon in a way that explains the way actual human beings act. Oh my God, interest rates are low, let's throw caution to the wind.

"Which brings us back to a taxpayer-funded "rescue" of homeowners. It's true that many people who bought homes in the last decade acted responsibly, made sizable down payments, and purchased a house within their means; they owe more than they paid through no fault of their own.

On the other hand, many people were speculators, fibbing about their income, lying about their assets, and treating their house as an ATM to finance cruises and flat screen TVs. Many banks were in on the game, knowingly placing people in homes they couldn't afford. Even if a bailout is justified, Washington is in no position to determine who's deserving and not. Any bailout punishes renters and Americans who were fiscally responsible by taxing them to benefit those who weren't.

Prices in some areas need to fall, and the market needs to return to normal. Eventually it will. All Washington can do is prolong the pain. "

Is a mortgage deduction taxpayer funded? My problem with this analysis is that it assumes a model of the economy to be the real economy, which has recently been proven to be a less than perfect mode of analysis. At any point in time, there are all kinds of competing incentives and disincentives moving people's decisions this way and that. It might well be that the government will, to some degree, "prop up" home prices in some theoretical model sort of way. But, on the other hand, if the people buying the houses today can afford to buy them and do, then the prices were not artificially propped up, and, even if they were or are, if people can and do freely purchase them, then the market worked. The market only fails if a significant number of people default, since there will always be some defaults. Does he really believe that new buyers, in this market, are radically prone to default?

Do I support the Fed's actions? Not really, no. But I understand what they're trying to do, and am not so sure that it can't work because of a theory I hold, however dearly.

Of course, I'm talking about houses. What works for tulips, I haven't a clue.

“Congress has allocated hundreds of billions of dollars to reset mortgages"

Floyd Norris considers the plight of a luxury home builder in the NY Times:

"Today, Toll reported its fourth-quarter revenues. They are down again, with cancellations ticking up. A bit belatedly, Mr. Toll realizes his fleeing customers were right: There really is an economic problem.

He has a solution:

“We urge Congress to stimulate demand by reducing mortgage rates and fees and by providing incentives such as a buyer tax credit for the purchase of all types of homes. We believe these initiatives would offer the greatest benefit for the taxpayer’s dollar.”

The way he sees it, stabilizing home prices is the only way to keep all the other efforts from failing.

“Congress has allocated hundreds of billions of dollars to reset mortgages, help people who are in foreclosure, and protect those who have been the victims of rapacious lending practices. We believe all of these goals are very worthy. However, we believe that, if home prices are not stabilized, these efforts will be for naught, more mortgages will go under, and the taxpayers’ money will have been wasted.”

Others might say that tax breaks and unreasonably low interest rates helped to get us into this mess. Making new buyers overpay runs the risk of a repeat of what happened after the Japanese bubble burst, when artificially high prices simply prolonged the pain."

Do I hear a second for a Nobel Prize in Economics for Mr. Toll?

"Mr. Toll was asked in the call if any members of Congress were on board to back his plea to subsidize home prices. He said there had been talks, but he had no endorsements.

As to why the government should be subsidizing home builders when there is an oversupply of houses, he said the country needed the construction jobs."

Here's my comment:

He has a solution:

“We urge Congress to stimulate demand by reducing mortgage rates and fees and by providing incentives such as a buyer tax credit for the purchase of all types of homes. We believe these initiatives would offer the greatest benefit for the taxpayer’s dollar.”

Technically, I believe that he’s asking the Congress to pay to lower and stabilize prices. The demand is there. They’re just asking for better terms for themselves. Lowering the price even more by themselves or easing terms should accomplish the same object. It’s called supply and demand. Oh, and let’s add Ricardian Equivalence just for fun. To the extent that the government chips in, it forces the private sector out. I knew I had a use for that concept.

— Don the libertarian Democrat

"de-leveraging has a long way to run yet,"

I did a post recently on foreclosures that was probably poorly thought out and defintely poorly expressed. However, note this response on Yves Smith:

We Should Move Away From Foreclosure System
I want to propose a thesis. The cause of this crisis was the foreclosure system itself. The crisis could have been avoided had a system been set in place that renegotiated mortgages immediately upon delinquent payments.

The cause of the crisis in the housing sector was a misallocation of resources by individual homeowners. The borrowers took mortgages that were eventually too high for them to afford. The loans/mortgages were based upon terms that were much more likely to lead to default/foreclosure.

But what if foreclosure had not been the option? What if the first option had been to renegotiate the mortgage/loan to a payment affordable to the borrower? The level of payment that the borrower could afford would then trigger a set of possible options:

1) Increase the price of the house
2) Increase the length of the mortgage
3) Base payments on percentage of income, so that they will rise as borrower's income rises.

Now, however it would be done, wouldn't this have been a better situation than the one we currently face? The reason to try a mortgage renegotiation plan now is to try and see if we can move away from the foreclosure system and devise one that keeps borrowers in their houses. Isn't that a sensible proposal?

Don the libertarian Democrat

November 8, 2008 9:59 AM

River said...

'The cause of the crisis was a misallocation of resources by the homeowners.' Not!

The cause of the crisis was too low interest rates for too long which always causes economic bubbles to form. In addition, loans were being made to anyone that could fog a mirror because mortgage originators could bundle the mortgages and move them off their books. The people originating the loans have far more financial saavy than the home buyers...So, why again is it all the homeowners fault?

Just as there is no reason to believe that there will be high earnings for equities going forward, there is no reason to believe that in a depression that homeowners can pay mortgages that are extended. For one reason, interest rates will be increasing going forward, not decreasing. If you are the holder of some of these mortgages why would you want to offer extended terms to the homeowners? Your solution sounds more socialistic than any I have heard so far.

Once again...There are two ways to fix this mess. Increase wages or decrease home prices. There is no third way.

How would lengthening the time frame of a mortgage help if interest rates will be rising and homeowners are worried about losing their jobs (rightly so) and taxes will be increasing?

November 8, 2008 10:19 AM

Here's my replies:

'The cause of the crisis was a misallocation of resources by the homeowners.' Not!

The cause of the crisis was too low interest rates for too long which always causes economic bubbles to form. In addition, loans were being made to anyone that could fog a mirror because mortgage originators could bundle the mortgages and move them off their books. The people originating the loans have far more financial saavy than the home buyers...So, why again is it all the homeowners fault?

Just as there is no reason to believe that there will be high earnings for equities going forward, there is no reason to believe that in a depression that homeowners can pay mortgages that are extended. For one reason, interest rates will be increasing going forward, not decreasing. If you are the holder of some of these mortgages why would you want to offer extended terms to the homeowners? Your solution sounds more socialistic than any I have heard so far.

Once again...There are two ways to fix this mess. Increase wages or decrease home prices. There is no third way.

How would lengthening the time frame of a mortgage help if interest rates will be rising and homeowners are worried about losing their jobs (rightly so) and taxes will be increasing?

November 8, 2008 10:19 AM

Don said...

River,Thanks for your comment. What got me thinking about this was a better way of deleveraging. I'm not suggesting mandating anything, by the way. Some people will definitely default. Obviously, also, many loans shouldn't have been made. I'm trying to suggest a process that will ease the misallocation of housing by saving as many borrowers as possible. Where mortgages are bundled, having a system of possible solutions already in place might overcome the problem of how to deal with such foreclosures. The reason a lender would want to do such a thing would be to avoid defaults, deeply depressed housing prices, and negative effects on the economy.

But, again, thanks for the comments. I'll consider them.

Take care,

Don the libertarian Democrat

November 8, 2008 11:23 AM

Don said...

River, By the way, your comment taught me a lesson. In trying to be a little provocative to get a few comments, I didn't clearly express myself. Thanks, Take care, Don

November 8, 2008 11:37 AM

So, what's important about this exchange was that it highlighted that I wanted to tackle de-leveraging.

However, today from Niels Jensen on John Mauldin's missive:

"Secondly, de-leveraging has a long way to run yet, not so much in the hedge fund community where I suspect that much of the damage will be behind us once we pass the next major redemption hurdle on 31^st December, but in society more broadly. Governments, banks, (some but not all) companies and, most importantly, the majority of households are more leveraged than good is. I have borrowed Chart 7 below from BCA Research, and it shows total US bank loans as a percentage of US GDP. Unfortunately, the picture would be much the same for many of the European countries. We are now facing a major de-leveraging cycle and it will suppress economic growth and put a lid on the stock market for years to come.

Thirdly, whereas I fully agree that the worst of the financial crisis might now be behind us, bear in mind that we have not yet seen the full effect of the economic crisis. We are only in the first or second innings of this recession, and the emerging market story has the potential to wreak further havoc. So do credit default swaps - or something else. Recessions are by nature quite unpredictable. There is one thing I am sure about, though. Just as for New Year's Eve, the more extravagant the party, the bigger the hangover. Prepare for this one to linger for a while yet."

What I was trying to do, at least in the area of mortgages and housing, is to try and find a way to ease the path of de-leveraging. After all, if you climb a tall ladder, it's better to slowly climb down than fall.

Actually, River understood what I was getting at:

"River said...

Don, thanks for your reply. The biggest problem with the deleveraging process is the speed at which it is occuring. Gearing up happened over many years, deleveraging is happening fast because everyone is rushing for the exits at once. I see no way to slow the process that is fair to those holding the homes and those holding the paper on the homes.

To award 'homeowners' more time to pay and/or lower their interest rates would be unfair to those holding the paper. If the government intervenes and backs the mortgages it will be unfair to all that didn't buy homes that they couldnt afford. In addition, to find in favor of home owners at the expense of taxpayers or those holding paper sets a poor example for future would-be home owners.

The government cannot continue to intervene in all facets of financial markets without total failure of those markets. Markets are supposed to be price finding mechanisims and setters of interest rates. The government has replaced the 'invisible hand' with it's own. Sooner or later the pool of available fools will be used up and insiders will be trading against other insiders. In other words, no market at all. Will we then return to the barter system?

The safeguards that were in the system and were removed should be replaced. Permanently. The financial sector needs to be relegated to it's traditional role of providing finance for goods and services. The financial system should not be the center of the economy of any country.

Of course, these are my opinions and you know what they say about opinions... :)"

November 8, 2008 8:03 PM

"Our macroeconomic problems require major public investments"

I wrote a fairly positive assessment of Jeffrey Sachs international aid plan, but this post scares me:

He starts with a tour more like a parody of a tour. Even if I wanted to follow his map, it is decidedly lacking in landmarks. It's just a general statement of biases, but go ahead and read them:

"Here is a quick tour of our macroeconomic miseries, with roots that go back 40 years."

Axiomatically, this must follow in Sachs' universe:

"America will sooner or later have to overcome its extreme allergy to taxation at a time when the government is hemorrhaging in deficits and when urgent public needs go unfulfilled."

"Our macroeconomic problems require major public investments in new technologies, infrastructure, public education, and poverty reduction. At some point soon, Americans will have to start paying for these investments themselves, rather than borrowing heavily from abroad. We are experiencing the structural shift from an economy relying on easy money and seemingly endless international borrowing to an economy that is gradually realizing that ultimately we will have to pay our way, especially if the United States wants to be a leading power. There are pressing domestic and global investment needs, and the money has to come from somewhere. The only place it can come from is an increased tax base, which requires abandoning the Reagan-Bush mythology."

So, what bothers me so much about this post? It's light on specifics, which I can handle as I am, and very heavy on a philosophy of high taxes and high government spending, which I need a xanax to handle. That seems to be his main point in this post, he wants higher taxes and more government spending. Period.

He does glancingly address issues and problems, like poverty, the environment, infrastructure, etc., to daringly call them issues and problems. I agree with his list, but have no clear idea to what extent higher taxes or more government spending would help. Show me the programs and needs, then I might be able to address these issues and problems. But as a statement of general principles, I sure hope President Obama ignores him, for the good of the country.

"While Reagan was crudely ideological, Clinton mildly reformist, and Bush simply crude in the application of these small-government doctrines, none of the recent approaches will do. It's time to stop talking about who can give away more to the public in rebates and start talking about investing in our future in a way that can save the poor, sustain the rest, and build a decent world for our children. Those are the real family values."

Come now, you're not talking about anything. Forget mythology, Sachs deals only in nostrums. One way to invest in our future would be to actually offer a specific and assessable plan. Try that next time, and I might not need a xanax.

“The Fed was promoting risk and subsidizing risk taking.”

Deal Book on the NY Times with this:

"The signals of the crisis were all around.”

That was the assessment of Theodore J. Forstmann, a founder of one of the earliest leveraged buyout firms, Forstmann Little & Company, who was interviewed recently on the “Charlie Rose” program. In the interview, which was shown last week, he talked about the causes of the current financial debacle and said the market turmoil was the worst panic he had seen in his lifetime.

Mr. Forstmann, who bought Dr Pepper and Gulfstream in a previous buyout boom in the 1980s, said he saw the latest financial collapse coming for a while.

The root of the crisis, he said, wasn’t greed or irresponsible regulators; rather, he put the blame on the “easy money” policies instituted under Alan Greenspan, the former chairman of the Federal Reserve. “The Fed had printed massively too much money,” the private equity executive said. “The Fed was promoting risk and subsidizing risk taking.”

This led to the creation of many “derivative securities that don’t create any real value,” he added."

Here's my response:

“The Fed had printed massively too much money,” the private equity executive said. “The Fed was promoting risk and subsidizing risk taking.”

This led to the creation of many “derivative securities that don’t create any real value,” he added.”

Excuse me, but where in this equation does human agency fit it. Are you an engineer? Was a gun to their head?

Promoting and Subsidizing don’t necessarily lead to lack of capital, too much leverage, poor loans, or anything else. It takes individual human actions to carry these events out.

Blaming the investments themselves, blaming the interest rates or money supplies as if they are a mechanical explanation of events, lets too many people off the hook.

The Fed made mistakes, but they were abetted by implicit and explicit government guarantees to intervene in a crisis. As well, various financial entities either committed fraud, were negligent, or were just plain stupid. I guess you could say that greed caused it, but you also need to see what allowed them to justify the risk over and above greed, which might well make an intelligent greedy person cautious.

The amount of see no evil, etc., coming out of some people’s mouths, people supposed to be intelligent enough to manage other people’s money, beggars belief, as well as our purses.

— Posted by Don the libertarian Democrat