[mike777]

I keep hearing from very smart people that the entire usa system almost fell apart because of reckless lending.


On the face of it this seems nuts.

I think these very smart people need to stop and think deeper, much deeper.

[hotShot]

Isn't it more likely that these smart people are right?

Are you suggesting that there was to much money around, so that save investments where all sold out. So the investors had to put their money to unsave investments?

[gwnn]

so are you smarter than them or is it just that you are more capable of deep thinking?

[P_Marlowe]

mike777, on Jan 30 2010, 12:32 AM, said:

I keep hearing from very smart people that the entire usa system almost fell apart because of reckless lending.


On the face of it this seems nuts.

I think these very smart people need to stop and think deeper, much deeper.

I think we are discussing a chicken or egg problem.

I would say, the problem arose due to the fact, that US americans were
on a reckless spending spree, but someone was providing the credid, i.e.
lending the money, which may well be virtual.

And the "cheap money" policy of your federal reserve (may be the wrong
institution) over the last ? years was certainly had certainly some stakes in
the whole thing, when was the last time the percentage was greater than
3?

With kind regards
Marlowe

PS: I dont understand a lot about economics, but I understand, that the
monetary policy of the european central bank was different than the policy
of the US central bank, the european percentage at least came near the 3,
and the difference was for years.

[Al_U_Card]

When you have a good credit rating (ie a reliable repayment potential) everyone wants a piece of that action.

The US (and it's tax-paying public) have one ginormous potential to repay.

Why not live on credit if you can get it? So much more, available, so much more quickly!

The source of this problem is the ability to siphon off (through speculation) some of the gas in that tank. As more and more is siphoned off, the engine falters from lack of gas and the car comes to a halt.

How you get more gas and how you impede the siphoning is the question.

[Winstonm]

The financial meltdown and crisis was caused by rational actors acting rationally...uh, well,.....maybe not.

[hrothgar]

mike777, on Jan 30 2010, 08:32 AM, said:

I keep hearing from very smart people that the entire usa system almost fell apart because of reckless lending.


On the face of it this seems nuts.

I think these very smart people need to stop and think deeper, much deeper.

Perhaps you should take the fact that you don't under what smart people talk about as a sign...

As usually, you're asking inane open ended questions.
You're no where near smart enough or informed enough to lead a Socratic dialogue.

If you want to be taken remotely seriously you need to step up to the plate, advance a positive thesis, and defend it.

If the great recession wasn't triggered by a real estate bubble, what caused it?

[Winstonm]

The problem I have with Chicago School economic thought is that IMO it is ideology rather than theory, a political dogma that resists close inspection. How can anyone take seriously a concept that smart apes act rationally and panic-prone markets made up of buy/sell decisions by those same smart apes are efficient?

I sense an almost dominionist-like attitude in those concepts, that man is so god-like he can dominate even his own non-rational nature and create markets that act like an all-knowing deity.

Not bad for a bunch of chimps who started walking on two feet only about 25,000 years ago. Problem is, if you start with two faulty assumptions and add a dash of monetarism, all you end up with is a Nobel prize for gall and a blueprint for disparity of wealth.

[helene_t]

Winstonm, on Jan 30 2010, 03:48 PM, said:

Not bad for a bunch of chimps who started walking on two feet only about 25,000 years ago.

It was a few million years ago, actually.

[Winstonm]

helene_t, on Jan 30 2010, 09:53 AM, said:

Winstonm, on Jan 30 2010, 03:48 PM, said:

Not bad for a bunch of chimps who started walking on two feet only about 25,000 years ago.

It was a few million years ago, actually.

You are right - we started watching American Idol about 25,000 years ago.

Quote

I think these very smart people need to stop and think deeper, much deeper.

This seems strange advice - the first rule says that when you find yourself in a hole, stop digging.

[kenberg]

As I learned in college, Aristotle thought of "cause" as having four separate meanings. Without digging up the old boy, we might take his idea that the word, unexamined, is a bit tricky.


"The cause was greed" "The cause was bad loans" "The cause was bad regulatory decisions" "The cause was the existence of the Federal Reserve system" (The latter being, I think, a quick summary of Ron Paul's views, and he is probably pretty smart. Pretty wrong, too, but pretty smart.)

It all reminds me of West Side Story:"This boy don't need a job he needs a year in the pen. It isn't a question of misunderstood, deep down inside him he's no good." Everyone sees cause through their own lens.

Ben Bernanke asserts that "too big to fail" is our major problem, and I agree. People will always do stupid things, but it's better if we can let stupid acts have consequences to the person who made the stupid choice. Many of the loans struck me as nuts. It would be good to prevent this, but we simply cannot prevent all stupidity. We need to try to keep it from doing in the rest of us. One of my youthful friends was oblivious to consequences. I had the right front of the car jacked up, working on the breaks. The left rear was blocked in place by a brick. He wanted the brick for something so he took it. Very stupid, but it was my legs that came within inches of being crushed. Actually he is still the same way. I was in a speed boat recently with him at the wheel. Good god I was glad to get back on shore. Anyway, my point is that we cannot put an end to stupidity but we need to protect ourselves. The main current application that I see of this is credit card debt. It's way, way too easy to run up crushing debt. If one guy does it, it's his problem. If it becomes widespread, someone will be there explaining why we need to bail these people out. I think I am done with that.

[barmar]

A good tutorial on what happened can be heard in the podcast Giant Pool of Money. The basic thesis is that banks and investors weren't happy with the returns they were getting on ordinary mortgages, there weren't enough of them for everyone. So they started offering loans to people who couldn't really afford them, foregoing credit checks, employment checks, etc. If these borrowers were really knowledgeable, they'd have known that this was too good to be true, but they were obviously attracted by the prospect of being able to own a home.

The lenders then thought that they were protecting themselves by bundling the mortgages -- diversification supposedly reduces risk. They also bought insurance against defaults. What they failed to realize is that diversification only adds safety if there's some independence between the securities that are in the bundle; but mortgages aren't independent, home values are often linked, and dependent on the state of the economy. Furthermore, the insurance companies were also investing in some of the same things, so when the market crashed, they couldn't afford to pay off.

You could say that it was due to unbridled greed, but I think that's being disingenuous. It's perfectly normal for investors to look for investment vehicles that offer higher returns, that's what investing is about. Bundling risky investments is also normal; consider venture capital limited partnerships, which expect 75% of the companies they invest in to fail, but hope to get a windfall from a few of them to make up for it. And who could argue with taking out insurance, or with unsophisticated borrowers being receptive to mortgages that are offered to them, no questions asked?

And when they started this, investors and brokers were making money hand over fist, so they were blinded to the potential disaster on the horizon, when the bubble burst. Capitalism, investing, the "American Dream", are all examples of greed; but, as Gordon Gecko said, "Greed is good."

[kenberg]

I don't know if greed is good or bad but, like sex, it isn't going away anytime soon. Actually both can do a lot of good, both can do a lot of harm.

We have always, most of us, believed that leaving people to their own best judgment is usually for the best, but we make exceptions. We have laws against child labor, for example. Even that is open to question of course. Before I turned 18 I strongly wished that the people who were protecting me from hard and dangerous jobs would mind their own business. We make at least some effort at stopping hustlers from preying on financially naive widows. Just as with sex, drugs, dog fighting, extreme sports etc we decide that some financial things are beyond the pale.

With respect to the meltdown and how to prevent another one, maybe some regulation will help some but I really would look toward how to keep disaster for some from being disaster for all. I won't be calling plays for the Colts next Sunday. I am very content with my almost total ignorance of the game. I am also content with my almost total ignorance of things such as credit default swaps. If this ignorance keeps me from getting rich, I don't mind. But I object to having to fork over my own money to finance their errors. If they thought the loans were a good idea, fine by me, as long as it does not cost me anything. Actually, for many, the loans were a very good idea. They made a bundle and left the rest of us holding the bag. Same with the houses. My tax dollars, in some cases, are helping people with a $500,000 house out of foreclosure. Buying it seemed stupid, lending the money seemed stupid, but they are getting me to pay for it so maybe I should rethink who is stupid.

I am not, btw, saying that the bailout was a mistake. I trust that it had to be done. But my general rule for helping people is that they are not supposed to be back next year for more. The past is past, but stupidity will not be bailed out next time.

[Winstonm]

Quote

"Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that 'this time is different.' That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy."

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

[PassedOut]

kenberg, on Jan 30 2010, 11:08 AM, said:

Ben Bernanke asserts that "too big to fail" is our major problem, and I agree. People will always do stupid things, but it's better if we can let stupid acts have consequences to the person who made the stupid choice. Many of the loans struck me as nuts. It would be good to prevent this, but we simply cannot prevent all stupidity. We need to try to keep it from doing in the rest of us.

I agree also. Risk takers must face the consequences of their choices or nothing will rein them in.

Paul Volcker discussed this in a piece yesterday: How to Reform Our Financial System

Quote

The phrase “too big to fail” has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.

As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.

In approaching that challenge, we need to recognize that the basic operations of commercial banks are integral to a well-functioning private financial system. It is those institutions, after all, that manage and protect the basic payments systems upon which we all depend. More broadly, they provide the essential intermediating function of matching the need for safe and readily available depositories for liquid funds with the need for reliable sources of credit for businesses, individuals and governments.

Combining those essential functions unavoidably entails risk, sometimes substantial risk. That is why Adam Smith more than 200 years ago advocated keeping banks small. Then an individual failure would not be so destructive for the economy.

Volcker goes on to outline measures needed to protect the financial system in these days when institutions have become so huge.

Given what we've just experienced, it will take substantial bribes from financial institutions to influence any legislator, republican or democrat, to oppose these measures. I note that some congressional opposition is already being expressed.

[Winstonm]

PO,

I think you missed the most important lines from Volcker's Op-Ed:

Quote

That is why Adam Smith more than 200 years ago advocated keeping banks small. Then an individual failure would not be so destructive for the economy. That approach does not really seem feasible in today’s world, not given the size of businesses, the substantial investment required in technology and the national and international reach required.”

What he is really implying is that commercial bank lending is not really the gasoline that keeps the engine running anymore. It appears he believes the capital markets are a necessary part to absorb the massive risk of global lending.

[PassedOut]

No, I didn't miss that. We can't go back to Adam Smith's ideal. Volcker's proposals accept the current reality, but put the risk back where it belongs.

Quote

What we do need is protection against the outliers. There are a limited number of investment banks (or perhaps insurance companies or other firms) the failure of which would be so disturbing as to raise concern about a broader market disruption. In such cases, authority by a relevant supervisory agency to limit their capital and leverage would be important, as the president has proposed.

To meet the possibility that failure of such institutions may nonetheless threaten the system, the reform proposals of the Obama administration and other governments point to the need for a new “resolution authority.” Specifically, the appropriately designated agency should be authorized to intervene in the event that a systemically critical capital market institution is on the brink of failure. The agency would assume control for the sole purpose of arranging an orderly liquidation or merger. Limited funds would be made available to maintain continuity of operations while preparing for the demise of the organization.

To help facilitate that process, the concept of a “living will” has been set forth by a number of governments. Stockholders and management would not be protected. Creditors would be at risk, and would suffer to the extent that the ultimate liquidation value of the firm would fall short of its debts.

To put it simply, in no sense would these capital market institutions be deemed “too big to fail.” What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital — and as ordinary businesses in a capitalist economy, to fail.

[Winstonm]

The problem IMO of Volcker's idea is that there are only about 25-30 of these so-called capital market institutions and their businesses are so interwoven that it is virtually impossible to have a single entity fail.

[PassedOut]

Winstonm, on Jan 31 2010, 03:02 PM, said:

The problem IMO of Volcker's idea is that there are only about 25-30 of these so-called capital market institutions and their businesses are so interwoven that it is virtually impossible to have a single entity fail.

Not sure what you are saying, Winston. Do you think nothing should be done, or do you think some other measures would be more effective?

[Winstonm]

PassedOut, on Jan 31 2010, 03:33 PM, said:

Winstonm, on Jan 31 2010, 03:02 PM, said:

The problem IMO of Volcker's idea is that there are only about 25-30 of these so-called capital market institutions and their businesses are so interwoven that it is virtually impossible to have a single entity fail.

Not sure what you are saying, Winston. Do you think nothing should be done, or do you think some other measures would be more effective?

PO,

IMO it is a systemic problem now and thus needs a systemic overhaul.