Lack of oversight caused the recession

[gopman]

Wrong. The recession would have been short lived followed by a strong recovery and stabilty in the housing sector. We would not have had the re-financing frenzy and the canibalization of future home sales. The housing sector would be stable right now. Recessions are part of the natural economic cycle and Bush/Greenspan tried to use the housing sector to make themselves look good, ruining housing forever.
Sometimes you just have to let recessions play themselves out. Government interference only made things worse back then. Just like it will now.
Government manipulation of markets makes things worse in the long run.

Why do you say the recession would have been short lived if interest rates had remained high throughout? Common sense (and empirical study of monetary policy) would suggest just the opposite. And that doesn't even dispute that rational stimuli don't cause bubbles.

 

[Dirty Harry]

Why do you say the recession would have been short lived if interest rates had remained high throughout? Common sense (and empirical study of monetary policy) would suggest just the opposite. And that doesn't even dispute that rational stimuli don't cause bubbles.

It's just the normal cycle of recessions without government intervention. Government interference and manipulation only makes things worse in the long run. Natural market forces would have worked had rational heads prevailed. I thought you were against government interference in markets.

 

[gopman]

It's just the normal cycle of recessions without government intervention. Government interference and manipulation only makes things worse in the long run. Natural market forces would have worked had rational heads prevailed. I thought you were against government interference in markets.

...and yet you think more regulation is the answer to this recession? Very strange. But you are right. I'm against government interference. That doesn't mean I'm against monetary policy. Neither was noted Libertarian Milton Friedman. Perhaps with some study you and the Ron Paul crew would not be against it either.

 

[Dirty Harry]

...and yet you think more regulation is the answer to this recession? Very strange. But you are right. I'm against government interference. That doesn't mean I'm against monetary policy. Neither was noted Libertarian Milton Friedman. Perhaps with some study you and the Ron Paul crew would not be against it either.

Regulation is different than manipulation. Government manipulation of the housing market created the housing bubble not regulation. Using monetarty policy to change the natural economic cycle will only lead to disaster in the long run. The monetary policies of the last decade have proven that.
Limited, rational regulation is neccessary to keep a greedy few from destroying the entire nation.

 

[samsmart]

They did in fact encourage lending to underqualified borrowers, and they explicitly encourage banks to buy mortgage backed securities through GSEs, but in the grand scheme they had relatively little to do with it. And there is relatively little they could have done to prevent it, or whatever causes the next financial crisis or recession.

I agree with you on this one. The government did encourage lending to underqualified borrowers, especially for mortgages. This was done to encourage home ownership for low-income earners.

But I don't think that this necessarily means the government is at fault for regulations. Rather, I think they're at fault for not regulating the construction companies to build homes specifically for low-income earners. While a low-income earner will need subprime loans they can't afford for mortgages for 4 bedroom houses, they won't need such a high mortgage to buy a small 2 bedroom house built specifically to be bought at a low price.

 

[gopman]

Regulation is different than manipulation. Government manipulation of the housing market created the housing bubble not regulation. Using monetarty policy to change the natural economic cycle will only lead to disaster in the long run. The monetary policies of the last decade have proven that.
Limited, rational regulation is neccessary to keep a greedy few from destroying the entire nation.

That post is at odds with about 100 years of empirical research. I don't even know where to begin. But you could start by comparing the monetary policy responses to the great depression and the last recession and the results.

 

[Dirty Harry]

That post is at odds with about 100 years of empirical research. I don't even know where to begin. But you could start by comparing the monetary policy responses to the great depression and the last recession and the results.

What do you mean? The last decade has proven how much damage irresponsible monetary policy can cause. We have only begun to feel the effects. The problem is some people think they have all the answers and can manipulate markets in order to achieve the desired results. It doesn't work. Look where all that research got us.

 

[phattonez]

LOL give me a break. Have you ever picked up a economics book? Ever heard of equilibrium in a free market and what is required to achieve that?

"Equilibrium," as you put it, will never be reached, no matter what. The free market, however, is the only way to tend close and closer toward it.

Who said government was a better alternative? I did not and far from it.

I did say that regulation to prevent a lopsided market that favours the strong (companies) over the weak (consumers) is needed.

The free market is a pipe dream and in the real world the market needs to be policed to insure as fair and free market as possible. That is why we have anti-monopoly legislation for example. That is why we have minimum wage, that is why we got unions... companies exploit anyone and everything they touch if they are allowed to do so. This is a fact based on 2000+ years of empirical evidence.

Here's the problem though. No one has all of the information. Minimum wage has always failed because there are always people that are worth less than the minimum wage. It has always lead to higher unemployment. Unions also have failed because in order to sustain higher wages they keep people out of work! They too do not know the correct wage for an employee. It's not that I necessarily think that unions should be outlawed, but these days they do more harm than good, especially because of government support.

Companies try to sell goods for the highest price possible. Workers try to get the highest salary possible. There's nothing fair or just, it's just the way that you get to the best efficiency possible. Artificially raise wages and you'll have a misallocation of resources. Artificially lower prices and you'll cause a shortage.

First off, the sub-prime mortage market that was the core of the problem, was not Fannie and Freddie. Fannie and Freddie is actually well regulated and would not have given out loans to those people who got the toxic loans in the unregulated market, because they were not eligible under Freddie and Fannie rules.

Proof (note there is none since you show that Fannie and Freddie didn't know how to make loans in the next paragraph which I respond to)?

The reason that Freddie and Fannie for the most part got into trouble was the economic downturn hit its customers first and hit them hard. And dont forget.. Freddie and Fannie hold a huge portion of the US mortgages and most of them are just fine. And dont forget that most of the toxic sub-prime lending as I have stated, happened outside the regulated market that Fannie and Freddie work in.

In other words, they gave out loans that failed. Where I come from, that's a problem that should be eliminated. They obviously didn't know how to judge the future well enough and should have gone bankrupt.

Secondly your total lack of economic knowledge is showing. Yes people who took out the loans should bear the risk, and guess what.. they are.. look at foreclosure numbers. Those that got the bail-outs were the people who were selling the crappy loans and those who bought up the crappy loans in the financial markets. And those people who took out the loans because of criminal activities by the lenders without their knowledge.. what of them? Should they bear the burden because the loan officer was a former pizza boy who added a 0 at the end of the year income number on the loan application without the knowledge of the person wanting the loan?

Sounds like fraud to me. I have always said that fraud should be prosecuted. However, if you sign a contract and there is no fraud, you should pay for the failure just like you pay when you lose at the casino.

Thirdly the only reason that those crappy loans were able to be given out was the total lack of regulation in the private loan market that gave out sub-prime loans. These loans were later on bundled in various impossible to understand financial products that financial companies paid the ratings agencies to give high ratings so they could sell them on to banks, financial institutions and others, well knowing that there was tons of toxic assets bundled in among the normal and good assets... and why not AIG had a fun insurance that made those assets perfectly safe since they were insured by AIG!

So then we should allow a correction. Let those companies that did this stuff fail. Right now we are creating a moral hazard that will only allow this stuff to continue. Without bailouts, do you really think that this would happen again? If these companies fail, do you really think that investors would go for that again?

That meant when the **** hit the fan, that it was impossible for the holders of these assets to see which parts were toxic and which part were not. That in turn meant that the banks to meet the rules that govern them, suddenly stopped lending till they figured out what assets they had (and they still have not) and that in turn brought down companies that relied on lines of credit that did not exist any more (Lehman Brothers is a prime example). This started a cascade of bankruptcies or near bankruptcies of major financial institutions and soon after companies at large, putting people out of work, and make the whole problem much worse. Those people out of work had mortgages they could pay when in work, but because they lost their jobs due to the financial melt down, then suddenly normal safe mortgages became just as toxic as the bad sub-prime mortgages that started the whole problem in the first place.. and the snowball effect was on.

If the government had not bailed out the major banks and AIG then the economic repercussions would have been mind boggling. Having 80+ of the mortgage/bank market go belly up ... not good.

Lets put it into perspective... what bank do you have your money in and your mortgage? What if that went belly up? Sure the Feds guarantee a certain amount, but you could loose a lot of money if the bank went belly up (provided you had more money than was guaranteed). And what of your mortgage? Well just because your mortgage holder goes belly up does not mean your mortgage goes away, but since your life savings are gone, and since you have a good chance of loosing your job.. see the picture? Its a cascade effect.

Deflationary spiral? Nahhhhh. It's never happened. People don't just suddenly sit on their asses and stop producing. You know this, and you know that deflationary spiral is a stupid concept.

Yes it is corporatism, you are 100% correct in that. However the free market would not change that one bit unless government regulated the market to avoid corporatism. Why? because companies will always be the strong party in any transaction with the consumer, the one with most knowledge and the one able to exploit the lack of knowledge by the consumer the most. This creates a lopsided transaction that is so far above the true equilibrium price. It is especially a problem in markets where there is lack of competition.

Let's say that this "exploitation" does occur. If I find out about it, what's stopping me from opening up my own business, lowering prices (and still making a profit since I charge somewhat less that "exploitative" prices), and stealing all of the business away from those companies? For someone who claims to know so much about economics, you think that you would understand a simple concept like competition.

So promoting the free market as some sort of saviour is a pipe dream.. the free market can not and will not work in reality and the only way we can get even close to having a "free market" is by having government regulation to prevent things like corporatism and exploitation of the consumer.

"[G]overnment regulation . . . prevent things like corporatism . . ."

I'm calling quote of the day. :laughat:

 

[gopman]

What do you mean? The last decade has proven how much damage irresponsible monetary policy can cause. We have only begun to feel the effects. The problem is some people think they have all the answers and can manipulate markets in order to achieve the desired results. It doesn't work. Look where all that research got us.

Only if you take a very misguided view of the causes of the recession. You should be thanking your lucky stars for modern monetary policy or we would be in another great depression right now.

 

[phattonez]

What do you mean? The last decade has proven how much damage irresponsible monetary policy can cause. We have only begun to feel the effects. The problem is some people think they have all the answers and can manipulate markets in order to achieve the desired results. It doesn't work. Look where all that research got us.

Regulation is also manipulation of markets, just fyi. :thumbs:

 

[Dirty Harry]

Regulation is also manipulation of markets, just fyi. :thumbs:

True , but what caused the housing bubble was the monetary policies that pumped billions into the sector while keeping interest at historically low levels. They tried to use refinancing and new home buyers to pull us out of recession. In doing so, they cannibalized future sales, ruining the market. They built and sold 20 years worth of homes in 10 years to people that were not yet ready to buy them..

 

[phattonez]

True , but what caused the housing bubble was the monetary policies that pumped billions into the sector while keeping interest at historically low levels.

No worries. I agree with you about the problems of our monetary policy.

They tried to use refinancing and new home buyers to pull us out of recession. In doing so, they cannibalized future sales, ruining the market. They built and sold 20 years worth of homes in 10 years to people that were not yet ready to buy them..

The government is still doing this. The tax credits are doing a disservice to the correction.

 

[Dirty Harry]

No worries. I agree with you about the problems of our monetary policy.



The government is still doing this. The tax credits are doing a disservice to the correction.

I know. They are doing the exact same thing that got us in the mess.

 

[Dittohead not!]

Housing prices increased due to demand for homes.

Demand for homes increased, as people increasingly saw housing as a good investment.

So far, we have a feedback loop, the rising cost fueling demand, which fuels rising cost. Meanwhile, the lenders looked at the short term gains, and made as many "creative" loans as possible. They then sold that paper at face value, so their risk was minimal.

The buyers, far from being exploited, saw creative financing as a way to buy property that they could not afford any other way, and so took advantage of rising prices. If you're a home buyer who could afford a $250,000 house with conventional financing, expecting a 10% increase the first year, you could expect a $25,000 gross return. If, on the other hand, creative financing allowed you to buy a $500,000 property, then that 10% would bring $50,000 back. As long as prices continued to increase, then it made sense to take a gamble and double your return. Lots of people made money while it lasted.

So far so good, but then came an economic downturn, buyers began to default, home prices began to adjust, and the feedback loop stopped. Now we have a new feedback loop:

Joe gambler who bought that $500,000 property saw it drop in value. He couldn't make the payments, and lost the house. That, in turn, decreased the value of houses as it increased the supply, while decreasing the demand.

Now, houses are undervalued, instead of overvalued.

Disaster.

Now, what we have to ask ourselves is how to prevent such a thing from happening again?

That, and, if houses are undervalued now, should I take a chance and buy one expecting the price to increase?

I'd really like to know the answer to that last one.

 

[phattonez]

I wouldn't buy a house now unless you're waiting for a long investment. We have a huge oversupply of houses, and most of the houses that you can buy are extremely overvalued since they're on the outskirts of cities. If you can get housing closer to the city then I'd go for it. Demand for that is only going to rise (assuming you're in a growing city).

What will prevent this from happening again? Simple, the market would. Allow the companies that did these things fail. You've shown that the activity can and will fail, and so companies will be less eager to do it in the future.

 

[pendulum_jaw]

To have a really free market you need full information on both sides of the economic transaction and that is impossible.

Please elaborate on this concept. What information are you referring to?

In a free market, information regarding efficient allocation of resources to their most crucial human needs is transmitted through the price system.

 

[PeteEU]

"Equilibrium," as you put it, will never be reached, no matter what. The free market, however, is the only way to tend close and closer toward it.

Oh so you have read a text book and yet then again you use the term "free market" when you admit it is impossible... classic.

Here's the problem though. No one has all of the information. Minimum wage has always failed because there are always people that are worth less than the minimum wage. It has always lead to higher unemployment. Unions also have failed because in order to sustain higher wages they keep people out of work! They too do not know the correct wage for an employee. It's not that I necessarily think that unions should be outlawed, but these days they do more harm than good, especially because of government support.

And you fail to see the failings of your opinions. You are blinded by your ideological bindings. First off as you correctly say no one has all the information, but then you go on an one sided attack. Minimum wage was put in place because the free market was broken and highly biased towards the employer because the worker was the weak party in the transaction. Workers were paid the bare minimum for ungodly hours in safety conditions that would alarm anyone with half a brain. That was the industrial revolution. Out of that came the unions, to combat the greed and abuses of companies. One of the first things put in place was the minimum wage so that workers could come out of poverty.

Does the minimum wage lead to higher unemployment? debatable. In my own country of Denmark we have had sub 5% unemployment for the last few years, even hugging the sub 4% I believe. Considering the mobility factor then that is more than full employment. We have a minimum wage. How does that fit into your world view? Germany has no minimum wage but has had higher unemployment.. There is no minimum wage in many places around the world but those places are hardly free of unemployment.. in fact they often had very high unemployment.

Companies try to sell goods for the highest price possible. Workers try to get the highest salary possible. There's nothing fair or just, it's just the way that you get to the best efficiency possible. Artificially raise wages and you'll have a misallocation of resources. Artificially lower prices and you'll cause a shortage.

And that means the free market is a pipe dream. Because companies want to press the prices up they put in discriminatory practices often with the help of government. Because of this the consumer suffers for higher prices than it should be. Look at the US. It suffers from insane drug prices because big pharma has managed to get a law passed that forbids competition. Insurance companies have for decades managed to keep laws in place that prevent competition across state lines. Internet and telecom providers have divided the US up, driving up prices by creating monopolies or near monopolies with high prices and crappy service. Time and time I see comments about bad cell reception in big cities.....the free market has failed big time.

Proof (note there is none since you show that Fannie and Freddie didn't know how to make loans in the next paragraph which I respond to)?

Private sector loans, not Fannie or Freddie, triggered crisis | McClatchy

More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.

Fannie and Freddie are not "private lending institutions".

Fannie and Freddie also hold or guarantee at least 40% of all US mortgages last I looked if not more and of those a small portion is sub-prime.

But because Fannie and Freddie hold such a large portion of US mortgages, then any economic downturn will hit them also when those people are unable to pay their loans due to no work. That is logical.

In other words, they gave out loans that failed. Where I come from, that's a problem that should be eliminated. They obviously didn't know how to judge the future well enough and should have gone bankrupt.

Yea they did, which happens for any lender. So what. A problem to be eliminated... how exactly can you eliminate the loss on loans by financial institutions?

Sounds like fraud to me. I have always said that fraud should be prosecuted. However, if you sign a contract and there is no fraud, you should pay for the failure just like you pay when you lose at the casino.

Of course it is fraud but it should never have been able to happen in the first place. It was due to lack of regulation and standards that it was able to happen on a large scale in the first place. It is ironic, that you need a license to do many things even in the US, but when it came to the private sub-prime market, anyone could set up camp regardless of education and sell loans to people who they knew could not meet even Fannie and Freddie requirements for a loan. As long as you closed the deal you would get paid... and it was fully legal at the time.

So then we should allow a correction. Let those companies that did this stuff fail. Right now we are creating a moral hazard that will only allow this stuff to continue. Without bailouts, do you really think that this would happen again? If these companies fail, do you really think that investors would go for that again?

You have no idea what you are talking about and the ramifications of letting the fail. This aint no corner stores we are talking about. The impact of having AIG fail, along with several of the US's biggest banks at the same time .. would be catastrophic. Any idiot could see that.

Deflationary spiral? Nahhhhh. It's never happened. People don't just suddenly sit on their asses and stop producing. You know this, and you know that deflationary spiral is a stupid concept.

And you should know better. Every action has a reaction. Once credit dries up, companies cant fund their day to day workings, which means workers dont get paid, which means workers cant pay their loans and this means that they stop consuming which in turn means the companies have to produce less since they are selling less, which in turn means they fire people (if they have not gone out of business already) which in turn means the people who get fired have to look for new jobs that do not exist and this in turn means the loans they have dont get paid and the spiral continues. No people dont suddenly sit on their asses and stop producing unless they have no choice. What choice do people have when there are no jobs and no credit to start up their own business? They sit on their asses even if they dont want too. Do you really think people choose to sit on their asses during the great depression? Of course not, but there was no jobs!

Let's say that this "exploitation" does occur. If I find out about it, what's stopping me from opening up my own business, lowering prices (and still making a profit since I charge somewhat less that "exploitative" prices), and stealing all of the business away from those companies? For someone who claims to know so much about economics, you think that you would understand a simple concept like competition.

Easy, no credit. Banks are not lending. Or the competition is so powerful that they drive you out of business with predatory practices.. it is pretty easy especially if there are no regulations to prevent such practices. You try to set up a supermarket next to a Walmart and cut prices under theres and see how long you last..

"[G]overnment regulation . . . prevent things like corporatism . . ."

I'm calling quote of the day. :laughat:

Good you can laugh but it is the truth under the condition that government is not like in the US where corporations own governments.

 

[PeteEU]

Please elaborate on this concept. What information are you referring to?

In a free market, information regarding efficient allocation of resources to their most crucial human needs is transmitted through the price system.

Information in as both sides knows everything.. cant be more clear. It is a basic theory of the free market.

By information I mean knowledge of everything in the transaction. That both sides know cost of production, prices, competition prices, needs of consumers and so on and so on. This way the correct equilibrium between seller and buyer will be found. As soon as one person has more information than the other, then the free market equilibrium is out of wack.

In the real world it is often the cost of the product that is the main information gab along for the consumer plus the availability of alternatives (either product or competitor). I mean how many consumers actually know what costs are in say a car, or a DVD or even food? Not many. They go after desires and price within a very local geographical area. A consumer can easily buy say a computer from one local place at a set price and not know that 10 miles down the road there is another shop (even the same company) that is selling the computer at a less price. That is lack of information and it blows the true equilibrium price totally out of wack and if a company or person can control this information they can make a killing.. that is why insider trading is illegal.

 

[washunut]

not sure what you mean

 

[finebead]

Good thread. No one thing by itself caused the housing bubble and financial system collapse. Everything mentioned in this thread contributed, and something I will contribute that nobody has yet mentioned, executive compensation, and another, where was the DEMAND for all those junk mortgages coming from, it was the investment banks.

Causes of the housing bubble that have been mentioned and are all true:
1. Interest rates too low in 03-04, fed funds at 1% 3 years after the recession ended in 2001. M3 money supply growth was also far to high, growing at 8% annually when GDP was growing 2%.
2. Govt. encouraging some lending to marginally qualified borrowers through the Community Re-investment Act. (This did NOT mandate all the predatory mortgage companies to lend to anyone with a pulse, the CRA only affected "depositories", or banks).
3. Lack of regulation, the fed had the power to regulate the mortgage industry and it chose not to. Glass Stegall was repealed in 1999, allowing the combination of banking and brokerage functions in a single institution. Derivatives were a huge problem, with Credit Default Swaps (CDS) sinking AIG, and there was no regulation of those instruments. Nobody knew how many CDS were outstanding when it hit the fan.
4. Fraud in the appraisal industry. How could houses be appraised for twice as much as they sold for 5 years ago?
5. Fraud at the bond rating agencies, Moody's, Standard and Poors, and Fitch. They would money launder a thousand crap mortgages that were junk grade (no doc liar loans), and all of a sudden you had a AAA Collateralized Mortgage Obligation (CMO). Their justification, "since WWII there has never been a year when home values went down nationwide". Think. It happened just a few years before that in the 30's, it can surely happen again. Trees don't grow to the sky.

Causes not mentioned yet and also true:
6. Executive compensation. Dick Fuld at Lehman Bros. took out 450 million dollars in the 5 years prior to the company dying. Use of excessive leverage allowed the profits to zoom up, caused the stock to shoot up, and allowed Fuld to get rock star rich, while he was taking excessive risk that took the company bankrupt in the end. This was predictable. Go to wikipedia and read the statement of Stephen Roach in 2004, he was chief strategist at Morgan Stanley, the US would face economic Armageddon. Same is true for Chuck Prince at Citigroup and Stanley O'Neal at Merrill Lynch.
7. Relaxation of the Net Capital rule by the SEC in 2005, allowing the 5 investment banks to increase their leverage from 15:1 to 45:1. This increase in leverage allowed them to increase their profits (in a very risky way), drive the stock, allowed the CEOs to become rock star rich and it eliminated all 5 investment banks as such within 3 years. Bear Stearns failed and was acquired for a fraction of its former market cap, Lehman went bankrupt, Merrill was sold for about 1/3 of its former market cap (and BofA wishes it hadn't paid that much), and Goldman Sachs and Morgan Stanley converted themselves to traditional banks and put themselves under control of the fed.

Re: #7, read here:

Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming.

On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

A lone dissenter — a software consultant and expert on risk management — weighed in from Indiana with a two-page letter to warn the commission that the move was a grave mistake. He never heard back from Washington.

One commissioner, Harvey J. Goldschmid, questioned the staff about the consequences of the proposed exemption. It would only be available for the largest firms, he was reassuringly told — those with assets greater than $5 billion.

“We’ve said these are the big guys,” Mr. Goldschmid said, provoking nervous laughter, “but that means if anything goes wrong, it’s going to be an awfully big mess.”

Mr. Goldschmid, an authority on securities law from Columbia, was a behind-the-scenes adviser in 2002 to Senator Paul S. Sarbanes when he rewrote the nation’s corporate laws after a wave of accounting scandals. “Do we feel secure if there are these drops in capital we really will have investor protection?” Mr. Goldschmid asked. A senior staff member said the commission would hire the best minds, including people with strong quantitative skills to parse the banks’ balance sheets.

Annette L. Nazareth, the head of market regulation, reassured the commission that under the new rules, the companies for the first time could be restricted by the commission from excessively risky activity. She was later appointed a commissioner and served until January 2008.

“I’m very happy to support it,” said Commissioner Roel C. Campos, a former federal prosecutor and owner of a small radio broadcasting company from Houston, who then deadpanned: “And I keep my fingers crossed for the future.”

The proceeding was sparsely attended. None of the major media outlets, including The New York Times, covered it.

After 55 minutes of discussion, which can now be heard on the Web sites of the agency and The Times, the chairman, William H. Donaldson, a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in The Federal Register a few months later.

With that, the five big independent investment firms were unleashed.

In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves.

Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly.

The 2004 decision for the first time gave the S.E.C. a window on the banks’ increasingly risky investments in mortgage-related securities.

But the agency never took true advantage of that part of the bargain. The supervisory program under Mr. Cox, who arrived at the agency a year later, was a low priority.

http://www.nytimes.com/2008/10/03/business/03sec.html?_r=1

This is why we had to bail out the banks. The SEC let them take on too much debt (a control mechanism added after the great depression, and the old limit was 15:1, and it was relaxed to 45:1), and then did not follow through under Bush's appointee, Chris Cox (repub).

 

[pendulum_jaw]

Information in as both sides knows everything.. cant be more clear.

Sorry, but saying "both sides knows [sic] everything" is anything but clear. It's completely ambiguous, which is why I asked you to elaborate.

It is a basic theory of the free market.

What is your basis for saying this? Please cite a source. I've read quite a few economics books and have never come across an argument claiming that a society in which mutual exchange occurs free from state intervention is not truly a "free market" because 'both sides lack complete information'. Why does a system of free exchange require 'knowing everything'? Perhaps you misunderstand what is meant by "free market"?

By information I mean knowledge of everything in the transaction. That both sides know cost of production, prices, competition prices, needs of consumers and so on and so on.

If you wish to sell me your computer for $500, why would I need to know the cost of production to know whether buying your computer is preferable to me compared with all of the other things I can spend my $500 on? All I need to know is the price and my own preference rankings to make that decision. As long as the government doesn't intrude on our agreement, we can make a our transaction--a mutually beneficial, free transaction (i.e. a free market transaction). Please explain why you think otherwise.

This way the correct equilibrium between seller and buyer will be found. As soon as one person has more information than the other, then the free market equilibrium is out of wack.

Your language is far too ambiguous to make any sense. An equilibrium of what exactly? Height? Weight? Penis size? What? If you are interested in academic debate, you need to make your points clearly and intelligibly. I'm only trying to understand your convoluted post. If you don't want me to understand, just say so and I'll stop asking.

In the real world it is often the cost of the product that is the main information gab along for the consumer plus the availability of alternatives (either product or competitor).

This sentence is not only ambiguous; it makes no sense. What is an "information gab"?

I mean how many consumers actually know what costs are in say a car, or a DVD or even food?

Again, consumers need only know the price of products to able to compare and contrast with their alternatives. You have not explained why a consumer would need to know the costs involved in production.

They go after desires and price within a very local geographical area. A consumer can easily buy say a computer from one local place at a set price and not know that 10 miles down the road there is another shop (even the same company) that is selling the computer at a less price. That is lack of information and it blows the true equilibrium price totally out of wack and if a company or person can control this information they can make a killing.. that is why insider trading is illegal.

You ignore so much in your analysis. The price difference may reflect a difference in location (accessibility), or maybe one of the stores offers better service or complimentary beverages, or better sales expertise, or any number of myriad things that can add to the price. Regardless, you're assuming that both situations are identical in every respect--clearly a false assumption since the two sellers are in reality different people in different places.

But this error pales in comparison to the one you make about price equilibrium. Your belief that an equilibrium price is possible or desirable is absurd! Firstly, it's not possible in reality because human wants and needs are constantly changing through time, thus constantly affecting the prices of millions of different goods of all orders through time. But even if it were possible, you wouldn't want a situation where all products remained at their equilibrium prices through time because there would be no profits! Without profits, people would cease to produce goods and services and the standard of living would drop!

The other major problem your thinking suffers from is your belief that sellers determine prices. Sellers don't determine prices; market forces determine prices (supply and demand).

Please reference the books that have influenced your education on the subject of economics. I would be very interested reading them.

 

[washunut]

Good thread. No one thing by itself caused the housing bubble and financial system collapse. Everything mentioned in this thread contributed, and something I will contribute that nobody has yet mentioned, executive compensation, and another, where was the DEMAND for all those junk mortgages coming from, it was the investment banks.

Causes of the housing bubble that have been mentioned and are all true:
1. Interest rates too low in 03-04, fed funds at 1% 3 years after the recession ended in 2001. M3 money supply growth was also far to high, growing at 8% annually when GDP was growing 2%.
2. Govt. encouraging some lending to marginally qualified borrowers through the Community Re-investment Act. (This did NOT mandate all the predatory mortgage companies to lend to anyone with a pulse, the CRA only affected "depositories", or banks).
3. Lack of regulation, the fed had the power to regulate the mortgage industry and it chose not to. Glass Stegall was repealed in 1999, allowing the combination of banking and brokerage functions in a single institution. Derivatives were a huge problem, with Credit Default Swaps (CDS) sinking AIG, and there was no regulation of those instruments. Nobody knew how many CDS were outstanding when it hit the fan.
4. Fraud in the appraisal industry. How could houses be appraised for twice as much as they sold for 5 years ago?
5. Fraud at the bond rating agencies, Moody's, Standard and Poors, and Fitch. They would money launder a thousand crap mortgages that were junk grade (no doc liar loans), and all of a sudden you had a AAA Collateralized Mortgage Obligation (CMO). Their justification, "since WWII there has never been a year when home values went down nationwide". Think. It happened just a few years before that in the 30's, it can surely happen again. Trees don't grow to the sky.

Causes not mentioned yet and also true:
6. Executive compensation. Dick Fuld at Lehman Bros. took out 450 million dollars in the 5 years prior to the company dying. Use of excessive leverage allowed the profits to zoom up, caused the stock to shoot up, and allowed Fuld to get rock star rich, while he was taking excessive risk that took the company bankrupt in the end. This was predictable. Go to wikipedia and read the statement of Stephen Roach in 2004, he was chief strategist at Morgan Stanley, the US would face economic Armageddon. Same is true for Chuck Prince at Citigroup and Stanley O'Neal at Merrill Lynch.
7. Relaxation of the Net Capital rule by the SEC in 2005, allowing the 5 investment banks to increase their leverage from 15:1 to 45:1. This increase in leverage allowed them to increase their profits (in a very risky way), drive the stock, allowed the CEOs to become rock star rich and it eliminated all 5 investment banks as such within 3 years. Bear Stearns failed and was acquired for a fraction of its former market cap, Lehman went bankrupt, Merrill was sold for about 1/3 of its former market cap (and BofA wishes it hadn't paid that much), and Goldman Sachs and Morgan Stanley converted themselves to traditional banks and put themselves under control of the fed.

Re: #7, read here:

http://www.nytimes.com/2008/10/03/business/03sec.html?_r=1

This is why we had to bail out the banks. The SEC let them take on too much debt (a control mechanism added after the great depression, and the old limit was 15:1, and it was relaxed to 45:1), and then did not follow through under Bush's appointee, Chris Cox (repub).

Very good post. I would like to discuss a bit more your #6, executive compensation. The first point I would make is that this problem is not by any means tied exclusively to the financial industry it is pervasive throughtout corporate America.

The irony is that in the past there was public outrage of pay to CEOs for non-performance. So corporate America decided that paying in stock was the better answer so that " if invesots ( owners) benefited " it was fine for CEOs to get outsized compensation.

This in turn led to Enron and now the rush for performance by bank executives.

We would be better off in my view if we paid salary and bonuses as the board of directos feel appropriate. To make that work propoerly there would need to be a way to eliminate rubber stamp boards, perhaps by making them accountable for their actions.

 

[OxymoronP]

These talented executives are in great demand amongst many competing corporations all over the world. Your socialist regulation would simply handcuff American corporations from bidding for their services, allowing foreign competitors to steal the best and brightest executives away. It would send a clear message to businesses to not do business in the United States.

But then again, it would be pretty consistent with what the American government has been doing to it's economy for years, cheered on by people like yourself. What's one more step down the road to tyranny when the country has already taken so many?

:lol: Not if those laws a global, which they will be since the US is far more relaxed regulating. So those "talented" people will stay.

 

[phattonez]

Information in as both sides knows everything.. cant be more clear. It is a basic theory of the free market.

No, it's a basic theory of Keynesians. Austrians readily admit that there is not perfect information but that the free market is the best option.

By information I mean knowledge of everything in the transaction. That both sides know cost of production, prices, competition prices, needs of consumers and so on and so on. This way the correct equilibrium between seller and buyer will be found. As soon as one person has more information than the other, then the free market equilibrium is out of wack.

Again showing your lack of understanding of economics. The value that a consumer places on an item has no relation to the amount of labor needed to create it. In the reverse sense, the price that a producer sets has no relation to the amount of labor needed to create it. Producers will set the price as high as they can. Period. It's up to consumers to decide whether or not the value the good more than the money they would give up in order to purchase it.

In the real world it is often the cost of the product that is the main information gab along for the consumer plus the availability of alternatives (either product or competitor). I mean how many consumers actually know what costs are in say a car, or a DVD or even food? Not many. They go after desires and price within a very local geographical area. A consumer can easily buy say a computer from one local place at a set price and not know that 10 miles down the road there is another shop (even the same company) that is selling the computer at a less price. That is lack of information and it blows the true equilibrium price totally out of wack and if a company or person can control this information they can make a killing.. that is why insider trading is illegal.

If that lack of information happens, then that place will make a killer profit. And this means that, well, nevermind. You doubt that competition exists.

 

[phattonez]

Oh so you have read a text book and yet then again you use the term "free market" when you admit it is impossible... classic.

Nowhere have I admitted that perfect information is necessary for a free market to exist. To demand it of capitalism but not other economic systems is illogical.

And you fail to see the failings of your opinions. You are blinded by your ideological bindings. First off as you correctly say no one has all the information, but then you go on an one sided attack. Minimum wage was put in place because the free market was broken and highly biased towards the employer because the worker was the weak party in the transaction. Workers were paid the bare minimum for ungodly hours in safety conditions that would alarm anyone with half a brain. That was the industrial revolution. Out of that came the unions, to combat the greed and abuses of companies. One of the first things put in place was the minimum wage so that workers could come out of poverty.

:stop:, let's not ignore history. People became BETTER OFF because of the industrial revolution. Even if you were making the lowest wages you were better off than you were toiling the fields and working for the landowner.

Does the minimum wage lead to higher unemployment? debatable. In my own country of Denmark we have had sub 5% unemployment for the last few years, even hugging the sub 4% I believe. Considering the mobility factor then that is more than full employment. We have a minimum wage. How does that fit into your world view? Germany has no minimum wage but has had higher unemployment.. There is no minimum wage in many places around the world but those places are hardly free of unemployment.. in fact they often had very high unemployment.

I never said that minimum wage was the only factor that creates unemployment.

And that means the free market is a pipe dream. Because companies want to press the prices up they put in discriminatory practices often with the help of government. Because of this the consumer suffers for higher prices than it should be. Look at the US. It suffers from insane drug prices because big pharma has managed to get a law passed that forbids competition. Insurance companies have for decades managed to keep laws in place that prevent competition across state lines. Internet and telecom providers have divided the US up, driving up prices by creating monopolies or near monopolies with high prices and crappy service. Time and time I see comments about bad cell reception in big cities.....the free market has failed big time.

There, that's all I needed to hear. You obviously don't even know what a free market is. Unless you want to debate capitalism, I'm done with you.