Who Should Pay the Price for the Popped Real Estate Bubble?

I want to make a simple point in response to so many people calling for heads to roll over the turmoil in financial markets, and to suggestions that the Fed should not cut rates if doing so bails out financial markets and prevents participants from fully realizing the costs associated with past behavior.

Recessions, popped bubbles and the like do not have to be somebody's fault and, as such, we don't necessarily have to extract blood from anyone to avoid it happening again. Perfectly reasonable actions a priori - in the sense of responding to the economic incentives that are in place - can still lead to bad ex-post outcomes. The people acting in the economic environment didn't write the rules, they're simply maximizing given the rules that are in place, so why punish them?

I don't mean to absolve those who committed fraud, etc., nor do I mean to absolve those who did fall down on the job - the rule makers and the ratings agencies - from any responsibility for the outcome. But I doubt that the people writing the rules intended to cause a meltdown, and it's possible they did the very best they could with the information they had. And it can be argued, credibly, that ratings agencies simply responded to the economic incentives that were in place (i.e. responded as expected to being paid by those they were rating).

We made mistakes in the regulatory environment, no doubt about it, and I hope we learn and fix the problems, but this Victorian call for someone to pay the price if there are problems seems overwrought, and it's getting in the way of talking about how to help people.

Here's something by Paul Krugman on this issue that I've posted before, and is worth repeating:

The Hangover Theory, by Paul Krugman: A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle--a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking--not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

The hangover theory is perversely seductive--not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted--for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality--with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression--with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity--of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes--investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover. ...

The hangover theory ... turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present. Yet the theory has powerful emotional appeal. Usually that appeal is strongest for conservatives, who can't stand the thought that positive action by governments (let alone--horrors!--printing money) can ever be a good idea. Some libertarians extol the Austrian theory, not because they have really thought that theory through, but because they feel the need for some prestigious alternative to the perceived statist implications of Keynesianism. ... But moderates and liberals are not immune to the theory's seductive charms--especially when it gives them a chance to lecture others...

We don't need a recession. If the Fed determines an interest rate cut is needed to keep the economy moving toward full employment, then it shouldn't hesitate to implement the policy because it believes it would send the wrong signal to financial market participants. I hope we don't get so caught up in our zeal to make sure people learn the right lessons from all of this that we allow "bad investments in the past" to bring about "the unemployment of good workers in the present."

Comments

[Sarah]

Thank you for this voice of sanity-- though I doubt it will be heard over the outraged squeals that are sure to follow...

[ken melvin]

So, "That's just the way it is" is not really a law of economics after all, or at least needn't be. And, the morality play was really from mythology all along? I thought so. Why is asking how should it be so damned hard? If man did evolve from the apes, he was 'drug' kicking and screaming all the way. Someday they'll find that fundamentalists gene for sure. And amybe the cure.

[ken melvin]

...maybe..

[Peter Schaeffer]

Of course, the Federal government should act to stabilize the real economy, including domestic employment of American workers. However, that doesn’t mean that buyers of mortgage backed CDOs based on 2/28 option ARMs with low FICO scores and high LTV ratios should get anything. Particularly if the loan was for property that doubled in the prior 3 years.

The last thing this country needs is for the Fed to reflate the property bubble by slashing interest rates to the lows (1%) that were provided after the .com bubble burst and 9-11. Doing so would only lead to a new round of property speculation and an even bigger debacle in the future.

A better choice would be to slash the value of the dollar (devaluation). This would expand the demand for exports and substitute domestically produced goods for some imports. More broadly it would allow the US to shift away from an unsustainable debt based economy towards an income based system. The current system requires an endless expansion of debt, propped up by serial asset bubbles. If we stay on the current course, the endgame will not be pretty.

The alternative is to shift to an economy where exports equal (or exceed) imports and domestic demand is maintained by a combination of income (not debt) based consumption and exports.

Of course, this requires shifting from an overvalued dollar (which we have now according to the IMF) to an undervalued dollar (at least for a while). This change will be fiercely resisted by the special interests that profit from the overvalued dollar. The list includes corporations that have outsourced production abroad as well as Wall Street interests that have accepted payments from the Chinese in exchange for using their influence to maintain the currency status quo.

Sadly, the change will also require overcoming the resistance of administration officials have been successfully suborned by the Chinese.

The bottom line should be clear. The US needs to move from a debt based economy to an income reliant system. Doing so means devaluing the dollar and breaking existing currency pegs. Powerful interests at home and abroad will tenaciously defend the status quo. However, it is still very much in our national interest.

[Ron]

Amen, Mark!

Now, wait a few minutes for the "I am really smart and I chose to rent for the past five years crowd, so everyone else should be punished" crowd to chime in...

I still don't understand how these folks think that a big recession will only hurt "greedy hedge funds" and "dumb subprime borrowers." I guess the shadenfraude folks have a portfolio comprised of special recession-proof assets and work at recession-proof jobs.

[RW]

As Barry Ritholtz points out (as guest editorialist on John Mauldin's behalf) it would appear that all of the following share some of the blame so where does one start ...or perhaps one should say where does one end?

Federal Reserve (FOMC) both in the monetary and regulatory sense
Borrowers
Mortgage brokers
Appraisers
Federal Government
Fannie Mae
Lending banks
Wall Street firms
CDO Managers
Credit agencies
Hedge funds
Institutional Investors (pensions, insurance firms, banks, etc.)

[calmo]

We don't need a recession...maybe a slap in the face with an "off" fish. Something.
You're a consumer, right?

We don't need a recession...even if the economy is booming along due to fires in the West (anywhere) allowing the entire country (ok, rusty, maybe not the MidWest) to roast weiners in the backyard (whatever) [Ok, people, not "whatever": it B your (non-MidWestern) residence that has escalated in value...unlike the primary source of your income: your wages --your work!...which has been trashed, if you would only expand that fledgling idea of opportunity cost] Weiners that may not be coming from China (caked with all that melamine) but weiners that were processed by illegals in Omaha whose hands could have been touching much worse than melamine (dog hair).
Why would we want to put an end to the big BBQ?
Smoke gets in your eyes and more: we glaze over the little details (like no-doc home loans...like pronouncements from authorities that housing fundamentals are sound...like dog hair inside the mustard dispenser!).
Life is good!
Shuddup an eat!
These hotdogs come with napkins and dental floss ...

Did everyone of us (those belonging to the set labeled 'we' in "We don't need a recesssion (or dog hair).") get a reasonable share of that boom that is coming to a close? (5 dog hairs on my bun! Count em! you?)
Did the housing boom moderate or exacerbate the wealth/income distribution under Greenspan's Fed?

Such civil language, "income distribution", and I know it's going to miss the mark on those barbarians who might soon be braking down the doors on those gated communities...if only they flossed.

[Richard A.]

The primary objective of the Fed should be to produce a smooth growing nominal GDP. Too rapid a growth in nominal GDP will in the short run cause excessive growth in real GDP and in the long run inflation will increase as real GDP growth moves back to a normal level. Slowing the rate of growth of nominal GDP will slow the growth rate of real GDP in the short run (recession) and decrease inflation in the long run.

I trust Bernanke to do the right thing. He did write a book on the Great Depression (which I have not read yet) -- "Essays on the Great Depression".

[S Brennan]

Mark,

I think this less about punishing those responsible and more about making those most responsible share the pain with those least responsible.

Remember the losers in the bubble are those who through shear forbearance did not buy when they really needed a house. It is to those good people you need to address your ideas on how they should be further punished by your bailout which will negate their patience and wisdom.

[David]

I agree that we don't "need" a recession, though some degree of recession is (IMHO) unavoidable due to the debt spending that has fueled growth lately. I think the Fed should try to minimize the extent of the recession as much as possible (without creating another asset bubble).

However, I don't think the right way to go about this is a knee jerk bailout of everyone who has made bad investments over the last 5 years. We should try to find ways for people to be able to realize their losses fairly quickly and get on with their lives. But imposing costs on everyone to channel money who have shown a proclivity to make dumb investment decisions is unfair and will probably slow the recovery in the long run. Put another way: taxing Warren Buffett to give to some guy who bought pets.com on margin isn't likely to produce a net positive result to society. Likewise, I'd rather the money for investments going forward be made by the sort of people who had the good sense to avoid investing in sub-prime mortgages.

[One Salient Oversight]

We can't blame economists and politicians back in the early 1930s for their contribution to the depression - yet we have learned a great deal since then and have hopefully inoculated ourselves from it happening again.

The fact that economies move in cycles does not mean that policymakers should simply close their eyes to the issues - and nor should it mean that solutions to market failures can't be learned.

The problem is that what we should've learned in the tech-bubble was forgotten as soon as people started to make money out of housing. Now we're in the bust again.

Policymakers should continue to seek out ways in which the boom-bust cycle can be averted by encouraging lower economic growth rates over the longer-term. Pushing the peaks and troughs into a straighter line and forgoing high growth in return for a lack of corrections or recessions is something these people should do.

I think the best place to start is by having stricter monetary policy. This current bust was caused by cheap money that was used inefficiently by the market. Rather than starting with damage control, policymakers (including those at the Fed) should simply adjust monetary policy to ensure that inflation never rises above, say 0.5% and never goes below -0.5%. With that done, the market can then sort its casualties out from the mess it has created.

[Winslow R.]

While I too have enjoyed these last posts as it shows you are not concerned solely with inflation. There still remains the question, how to alter the system so it functions better?

I would like to see you and Krugman get beyond 'tinkering' and shift those specialists of finance into more useful professions. Some collapse is necessary to get them moving on to new professions, though I'd like it to be targeted at those who feed at the top of this broken system.

Peter wrote: " Powerful interests at home and abroad will tenaciously defend the status quo. However, it is still very much in our national interest. "

There goes our 'free lunch'. While I do not disagree that your prescription might work to wipe out all debt with inflation, hard working Americans would be asked to 'defend' the world and work that much harder - think Germans and Japanese times two. Tempting, but I'm not convinced it is the 'best' path.

One wrote: "Rather than starting with damage control, policymakers (including those at the Fed) should simply adjust monetary policy to ensure that inflation never rises above, say 0.5% and never goes below -0.5%."

Why do you think the fed reaction function even approaches this capability?

[esb]

There is little that I wish to add to the debate other than to say that at least here (on this site) it is reasoned and not rabid (as it is on some other sites).

The "thinking class" is divided on this issue, much as the "voting class" is divided on many political issues. Divided between those who are comfortable with an ever escalating level of moral hazard (the privitization of gain accompanied by the socialization of loss) and the perpetual inflation it engenders and those who find the entire design of such a construct disgusting.

"We're in the American dream business" means go try to borrow yourselves rich. Debt is you best friend.

Disgusting. Call the halt now, while we still (possibly) can.

[KnotRP]

1. No matter what we do, this will happen again.

2. The recession is baked in the cake already - we're
just waiting for the "ding" from the oven timer.

As for the "culprits", we were about to fall off a
depressionary fence in 2002 when 1% came
along. It was crystal clear to everyone at that
time that housing was going to be used to
force feed an economic reflation. Pretty much
everyone with a measurable IQ knew why this
was being done, so the answer to "who knew?"
is pretty much everyone.

The blame, if there is any, goes to those who
actually thought you could reflate given the
pressure globalization was/is exerting on wages.
That was a truly monumental blunder, but I
do believe it was an honest mistake...or maybe
wishful thinking based on rear view mirror driving.

[Gavin]

An analogy can be made with forest fires. If you keep putting out small forest fires, dead wood and other debris accumulate providing fuel for a much larger and more destructive fire that is impossible to contain.

Does this have any lessons for dealing with the current subprime mess?

[Robert]

If the Fed determines an interest rate cut is needed to keep the economy moving toward full employment, But the problem is not full employment. The problems include:
1. Low income for the bottom 50%.
2. In part because of 1, high debt for the bottom 50%.
3. Contributing to 1, a CPI that is clearly biased against the poor.

After all, everyone says we have a labor shortage. That is why we have to be so protective of our millions of illegal immigrants and the capitalists who exploit them. I don't see how a rate cut helps any of this. It will simply contribute to the continued transfer of what remaining wealth the poor have to the wealthy through the most insidious tax of all: inflation.

[gordon]

Prof. Thoma says: "..But I doubt that the people writing the rules intended to cause a meltdown, and it's possible they did the very best they could with the information they had.".

That makes me think of, say, a space shuttle disaster; everybody taking precautions, testing systems, trying to identify and fix faults. Even with all that, some disasters have occurred. When they do, we don't execute everybody at Mission Control, because we believe they tried their hardest and after all, there are still a lot of unknowns.

But the subprime meltdown/bailout wasn't like that. Lots of people saw this coming. We knew what a bubble is. We knew what a Ponzi scheme is. Regulators weren't really trying hard (whatever happened to Glass-Steagall?). There weren't many unknowns, except the exact date when it would happen.

Nor is it impossible to try to avoid a recession and still make sure those responsible feel some pain.

[Idaho_Spud]

RW says:
"As Barry Ritholtz points out (as guest editorialist on John Mauldin's behalf) it would appear that all of the following share some of the blame so where does one start ...or perhaps one should say where does one end?

Federal Reserve (FOMC) both in the monetary and regulatory sense
Borrowers
Mortgage brokers
Appraisers
Federal Government
Fannie Mae
Lending banks
Wall Street firms
CDO Managers
Credit agencies
Hedge funds
Institutional Investors (pensions, insurance firms, banks, etc.)"

And I agree... now who will (by one means or another) end up bailing out all these jackasses? Those of us who don't fall into the above categories.

This sucks!

[KirkH]

I'm one of those wacky libertarian Hayek readers. I always assumed that the booms and busts were due to technological change and creative destruction outpacing our ability to adapt. Which makes them inevitable and attempts to create money to smooth out the bumps necessarily leads to asset misallocation (NASDAQ, housing bubble). That misallocation slows the economy as you have productive people giving up their jobs to flip condos so the economy eventually suffers. At which point the Fed steps in to engineer the next bubble. And on and on until things get so out of whack (housing) that the eventual recession required to allow the next generation of business models is devastating.

Businesses that should go out of business manage to stay alive longer than necessary. Technology continues to advance so the eventual collapse of that industry is even more dramatic and sudden under our current system. Newspapers are facing this right now. They managed to stay alive by leaching off of the housing bubble through ads.

[PrestoPundit]

"nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present."

This is classic Krugman duplicity -- and shows that he has zero understanding of the basic economic coordination problem through time. Come to Orange County, CA and take a look at the thousands unemployed in the mortgage business and the many more thousands recently put out of work in the housing construction business (like my neighbor across the street). Sorry I have to say it but Krugman is hardly the bright bulb in the pack discussing this matter. (And he certainly _doesn't_ know the first thing about Hayek and the "Austrian" account of economic dis-coordination through time.)

[PeterRabid]

Sorry, I can't help wondering why we keep tinkering to preserve unchanged an economic system that demands ever more consumption, ever more McMansions, ever more energy consumption, ever more pollution,ever more inequality, etc.

No, we don't need a recession, we need another gigantic depression, the only way to make real political and economic change possible in the crazy USA inspired economy.

[Oupoot]

The economy is a complex system of interactions. The Fed and monetary policy makers across the world try to make the process of economic growth as smooth as possible, but there may be times when even the best of intentions may not be enough.

Just like life, the market is fraught with risks which economic decision makers try to manage as best as possible. The solutions provided by the Fed and others after the tech bubble burst averted a serious recession at the time. Stated differently, it minimised the overall impact of the shock (realised risk) of the tech bubble-burst. I am sure they were aware that their option of lowering interests rates may have created risks which they would have to cope with in future. Coupled with the development of more sophisticated financial instruments, their actions in 2001 led to the a housing bubble a few years later. Now, its about managing the existing bubble-burst as best as possible in order to minimise the impact on the overall economy. Certainly, whatever they do, risk will remain part of economic life. Their actions will create future risks which we must just hope we are able to manage them as best we could. I.e. reduce the possibility that the risks are realised and/or the potential impact if the risks are realised.

Certainly, there are many people that have speculated on the housing bubble, on both sides: lenders and borrowers. Some have profitted handsomely, while others have burned their fingers. Minimising the impact on those that burned their fingers is not irresponsible governing. There are many other tools available to those seeking economic justice to ensure those that benefitted from the bubble compensate the losers, at least to some degree. You have a Voice. You also have a Vote.

[gordon]

Serendipity is a wonderful thing. I just read this article in The Independent which notes the publication on 8 Aug. 2007 of a Federal Reserve paper entitled: "The Rise in US Household Indebtedness: Causes and Consequences". A quote from the paper: "As illustrated by the recent developments among sub-prime mortgage borrowers, excessive accumulation of debt can, in some circumstances, lead to financial distress. Moreover, the reaction of financial markets to these developments raises the possibility that credit availability could be hampered for a larger group of households, which could, in turn, have effects on the broader economy".

Who knew?

The authors of the paper are Karen Dynan, the chief economist of the Fed's household and real estate finance division, and Don Kohn, the Fed's vice-chairman and, thus, Ben Bernanke's deputy.

I've heard of fiddling while Rome burns, but this is actually using the firelight to read the music.

[Lafayette]

MT: We made mistakes in the regulatory environment, no doubt about it, and I hope we learn and fix the problems, but this Victorian call for someone to pay the price if there are problems seems overwrought, and it's getting in the way of talking about how to help people.

Te absolvo

No, sorry, can't buy this. Absolving the people involved, as much as you say you want to avoid, is NOT wise – whether they wrote the rules or not.

We are all moral persons and it is our obligation to understand the morality of a context within which we function. It was time to say to oneself, "No, I won't sell this infamous crap and your incentives to do so will not change my mind." And walk away.

This is not religion and one need not fear the retribution of any God. It is simple decency, based upon the principle that we must accept to do unto others as we would have done unto ourselves. This notion is NOT religious (to my mind) -- it is just good, common sense in a functioning society.

The problem arises as ethical values are diminished to secondary priorities when confronted with the prospect of personal gain. Putting someone in a box, giving them a telephone listing and a silver-tongued sales line and a "good incentive" may seem like pragmatic marketing to many, but we are not selling innocuous dish-washing powder. The product being sold was debt, quite another matter altogether and far more complex in its particular form to the average consumer.

I am not sure what happened to ethics in America, but I am sure ethical behaviour (truthfulness, honesty, and decency) is key to a society where a people live in social harmony. If these values are left in suspension, in order for personal gain, then a society descends into depravity – a sort of free-for-all where the rules are made up as we play the game.

The ends justify the means was always an excuse and never an acceptable reason for immoral behaviour. The road to degeneration is paved with such silly nonsense.

Those who are responsible for the sub-prime mess (both legally and morally) should question their actions. Have I been fair to my fellow citizens, that is, my clients? I doubt many can answer that question without flinching. And if they can, they haven't a shred of decency within themselves.

NB: Let's remember the moral imperative established at Nuremburg when the Nazis tried to excuse their behaviour by arguing "I was only following orders" or, "It was the context within which we were forced to live by our leaders". We are all individually responsible for our behaviour, which is often a difficult choice we must make.

[realpc]

I thought Krugman complained when interest rates were cut after the internet crash. This stimulated real estate and kept the economy going, leading to the current possible crash.

If I remember correctly, Krugman has completely contradicted himself.

The real estate crash is correcting prices, and maybe house prices will eventually become reasonable. But not if, as Krugman recommends, the government intervenes to make everything nice for the moment.

The economy does need corrections, what goes up must come down. What is illogical about that, and why does Krugman say the opposite when criticizing Republicans?

[anne]

"I thought Krugman complained when interest rates were cut after the internet crash."

You thought wrong, you think wrong; the need was for a series of interest rate cuts to avoid a serious recession which was precisely why the Federal Reserve acted strongly beginning in January 2001 and why the economy recovered so readily even in the midst of a severe externally caused shock. The Federal Reserve will act now as conditions warrant to protect against a serious recession, just as the mandate requires. Paul Krugman has never argued against this mandate.

[bullbust]

but this Victorian call for someone to pay the price if there are problems seems overwrought, and it's getting in the way of talking about how to help people.

I think you are being obtuse here. It's not as if there is no price to pay. There is. This is more about who should pay the price.

Is it the people who acted prudent? Or the people who acted reckless?

If reckless behavior is rewarded, then that too sets rules. And people will react to those rules. That itself may be nothing unexpected. What is fundamentally unfair and unjust is the fact that the rules are arbitrarily set, and decided, after the fact (depending on how big is the bailout mob)

If the rules are simply stated clearly - Thou shall always be bailed out - then by all means, I would agree with you.

http://www.time.com/time/magazine/article/0,9171,1655723,00.html

.. in the housing market, people fall into three categories. Some, mostly young folks, are trying to buy their first home. Some, at various stages of midlife, own a home but will trade up someday, or at least think about it. And some, mostly older, are trying to sell and downsize. Who is served by soaring house prices? Not the first group: rising prices make it hard for those people to get into the game. Not the second group: what it will have to pay for a bigger house is probably increasing faster than what it can get for the current one.

The only clear beneficiaries of rising house prices are those, generally older, who want to sell their home and buy a smaller one or none at all. These people, on average, have benefited the most from the spectacular rise of real estate prices over their entire adult lives. If they have to forgo part of that windfall, it is no tragedy. ...But any plan that would prevent home prices from declining would be foolishness squared. Genuine tragedy deserves sympathy and help, even if it is the result of your own foolishness. But when we do not even guarantee basic health care, it would be nuts to think about making protection against real estate losses part of the social safety net.

So let us be honest - what Mark Thoma is proposing here is not something neutral. It clearly benefits one group of people as surely as it screws another group.

And calling anyone in the latter group as being driven by Victorian morality - when all they are doing is acting in their own economic self interest is dubious at best.

The latter group also is "simply maximizing given the rules that are in place, so why punish them?" What is the justification to change the rules now, when the game is almost at the end?

Is there any justification other than brute power?

[anne]

"Sorry I have to say it but Krugman is hardly the bright bulb in the pack discussing this matter. (And he certainly _doesn't_ know the first thing about Hayek and the 'Austrian' account of economic dis-coordination through time.)"

Yes; the problem is dis-coordination, especially dis-coordination through time, though really the problem is a comical mastery of pretending to write sense by Austrians who never make sense. Remind me to dis-coordinate breakfast. Hayek?

[baileyman]

The recent mortgage/house value bubble was one of all of us together agreeing to sell each other our houses at increasingly higher prices over time. GDP rose. But this is a dig-a-hole-and-fill-it-up piece of the economy. If that part of GDP were to disappear, causing what we would call a recession, would that in fact be a recession? Would it be a bad thing?

[anne]

"And on and on until things get so out of whack (housing) that the eventual recession required to allow the next generation of business models is devastating."

Paying no attention to Austrian "never do nothin about nothin" nuttiness is of course why there has been no such devastation since 1932, and why there will be none presently.

[anne]

Yes; for millions of people a recession would be a bad thing and a serious recession would be very bad, and count of the Federal Reserve to try to prevent a recession because that is what the Fed is mandated to do along with limiting inflation. The people who are most hurt by a recession are just those people most needing protection. What is Fed is doing is gauging both how much economic slowing can be soon anticipated and what in turn investors anticipate.

[xtoph3r]

.. in the housing market, people fall into three categories.

WRONG.

This is all so disingenuous it is laughable: The people who were trying to "maximize" were the flippers who bought two and three homes with EZ money, lent by mortgage companies who abandoned underwriting standards because Wall Street plutocrats invented a way to "diffuse risk" by selling the worthless loans to big institutions and foreign governments.

The whole thing was a massive SPECULATIVE BUBBLE that encouraged reckless borrowing excessive spending (want me to show you a picture of Escalades and jet-skis parked outside million-dollar McMansions belonging to hair-dressers?)

And now that the bubble has popped you want to pretend that it was just lil' ol' grampa and grandma who made out with a little nest egg?

LOL! Stop. You're killing me!

[ECONOMISTA NON GRATA]

We need to add a couple of catagories to Barry's list.

- soccer moms
- yuppies
- neurotic parents of gifted children
- Joe Six Pack
- Mom
- Dad
- Spoiled Brats
- Me

Anyway that you look at it, the Fed has a tough choice to make to try to save our collective greedy asses. It's looking more and more like a "DEFLATION" scenario to me.

I'm good with whatever they do, either way, my job is to take care of Econolicious & Co.. Everybody else can go to hell in a handbasket, so far as I'm concerned.

And that, Laides and Gentlemen, is what makes "America Great".

"Federal Reserve (FOMC) both in the monetary and regulatory sense
Borrowers
Mortgage brokers
Appraisers
Federal Government
Fannie Mae
Lending banks
Wall Street firms
CDO Managers
Credit agencies
Hedge funds
Institutional Investors (pensions, insurance firms, banks, etc.)""best

Best regards,

Econolicious

[wimpie]

"You thought wrong, you think wrong; the need was for a series of interest rate cuts to avoid a serious recession which was precisely why the Federal Reserve acted strongly beginning in January 2001 and why the economy recovered so readily even in the midst of a severe externally caused shock. The Federal Reserve will act now as conditions warrant to protect against a serious recession, just as the mandate requires. Paul Krugman has never argued against this mandate."

Anne, what a bunch of baloney!! History has already proved that nonsense to be, well, NONSENSE.

Reading Mark's missive and Krugman's baloney is SICK.

When "you"(Krugman, Thoma, Bernanke, etc) are wrong admit your damn mistakes. It is absolutely "retarded to stay in denial mode, which you are clearly are all in. Give it up!!!!!!!!!!!!!!!!!!!!!!!!!!!

[Mickey]

This is Krugman exhibiting the limitations of being a liberal. Is there ever too much debt, Paul? Can't see the forest for the trees, bud? And there is nominally an entity in charge, the Fed, ha ha.

[Turnip]

As much as I would like to share Anne's dogged faith in the FED, it is over-obvious what the FED really fears... full employment, rising wages and deflating asset prices.

Why is their now so much talk of "saving jobs" when our economy has been busily destroying what little decent wage-earning employment remained over the last 30 years? "Deflation is death" we hear, but why does it seem that the average Japanese worker had it much better during the same period of deflating prices in Japan.

The FED clearly applauds the destruction of decent non-professional jobs, fully-funded pension plans, good health benefits, reasonably cost-adjusted government retirement benefits and money in regular savings accounts. But Lord... don't touch asset prices.

Do you think the fact that our anemic GDP is so dependent upon credit creation has anything to do with the FED's obsession with asset prices?

And Greenspan actually had the nerve to embellish on the fact that the FED does not target asset prices. Hah... hah... hah.

So Mark has it right, we must now stoke the fires of credit creation at all costs. We must save asset prices. We must save our ability to borrow ever-more larger amounts of money. We must save what's left of those poor fools' jobs... for how else will they continue to send Wall Street those critical monthly payments?

[anne]

"This is Krugman exhibiting the limitations of being a liberal. Is there ever too much debt, Paul?"

Of course the answer as any decent investor knows is "no." But, interestingly, a Republican President and Republican Congress, an extremely conservative president and congress made sure that a massive government surplus inherited in 2000 would be debt and debt that has grown and will grow faster than the economy can grow. So we are all conservative government debt.

Should I add the lunatic series !!!!!!!!! to be understood?

[Nels Nelson]

Anne,

I have a couple of questions. Given your belief as stated numerous times over the years on this and other blogs that there was no housing bubble, do you concede that there was indeed a bubble and admit that you were wrong? If you were wrong on this could you not be wrong about how the aftermath should be dealt with?

[save_the_rustbelt]

After the fraud bubble burst the Bush administration sent Martha Stewart to jail, and the rest of the Wall Streeters were given "rich white guy immunity."

No wonder they think the rules of law and economics do not apply to them. Sandy Weill is enjoying a wealthy retirement, so what if he and Grubman scammed ATT investors?

The home owners are going to suffer through foreclosures, cause they are just the little people, let the rich white guys on Wall Street eat their own mistakes.

And about two years ago I predicted a recession starting 3rd Q 2007, regrettably I may have been right, but sometimes we have to drain the swamp and start over (and besides, we've been in a recession for six years and we survived somehow).

Calmo: no fires here, just floods and tornadoes

[ken melvin]

How moral - thus do I, so must yea?

says...

Ummm...
I think that there are some things should be cleared up here. This is getting very heated, but there is not much light being shed.

Think of what happened in Japan. There was a liquidity trap, so monetary policy became ineffective. So fiscal policy (infrastructure investment) had to be used to try and kick start the economy, but this resulted in ballooning government debt and resulted in much corruption (and didn't do much for the bad debt problem of the banks).

What SHOULD have happened in Japan? They should have printed money and spread it around (as evenly as possible in my mind so it would filter up to the most productive). Issuing government paper just promised future tax revenues to the already rich and discouraged productive investment.

I think there was a legal issue to stop them doing that in Japan. If there really is a deflation (the result of the threatening deleveraging) there is no doubt in my mind that would be the correct policy.

I always go back back to monopoly - pass go and collect $200 dollars - it keeps the game going.

[reason]

That was me - why does typepad keep losing my logon?

[reason]

By the way, I think financial market reform of some sort is badly needed. Exactly what should be done to limit risk in the rapidly evolving modern financial world is not clear to me. But we need to go back to some sort of controls on leverage and unregulated money creation.

[robertdfeinman]

The people acting in the economic environment didn't write the rules, they're simply maximizing given the rules that are in place, so why punish them?

This is the crux of the matter. Economic behavior is not an ethics-free discipline. Every choice creates winners and losers. To think otherwise is to be blind to reality. When one sector gets unreasonably rich then others get less rich even if their wealth is nominally increasing. Every dollar put into the hands of the Walton family is the result of a dollar squeezed from their workers, suppliers and customers. Government could insure that there is as little distortion as possible. That is, that the power of various segments within society is not too lopsided, it just has chosen not to. It is also not obvious that those acting didn't "write the rules". As I've stated several times the super wealthy have been writing the rules for the past 40 years, and doing it to benefit their own self-interest. Those who are in their pocket aren't likely to call attention to this fact.

Other nations have chosen policies to limit wealth and power and to distribute benefits more equitably. What makes the US unique is that many people in this country seem to like getting economically screwed. The Horatio Alger stories still are persuasive, apparently.

Why this is so has puzzled many starting with Thomas Frank and "What's the Matter with Kansas?", but it seems to be a combination of a residual belief in the pioneer spirit, an effective propaganda machine funded by the super wealthy and appeals to cultural chauvinism and jingoism.

This formula has worked for nearly 150 years and has allowed us to dehumanize one foreign country or nationality after another. You can start with the gunboat diplomacy used in South America, move on to the Philippines and on to Japan, Germany, Korea, Vietnam and the middle east.

As for "punishing" the perpetrators this may appeal to Puritanical prejudices, but it never works. First, the rich can out wait any economic downturn. If worst comes to worst they can just pick up and go somewhere safer. Second, those who will be responsible for the next cycle of excess are not those currently involved. There is always a new generation of sharpies and marks coming along. Neither group learns from history.

Doctors have a code of ethics, maybe economists need to think about formulating one too. "First do no harm" is a good place to start.

[baileyman]

Anne supports valueless activity as long as someone gets a job out of it?

[calmo]

Let me poke this once more:We don't need a recession. Have we had enough of pushing around that big nugget, "we"?...Have we? (We lettuce head choppers, we managers of lettuce head choppers, we contractors to lettuce head chopper managers, we lenders, we investors, we money managers?) [Apparently not]

We have.

...and the rest of us are just brain dead...lettuce heads.

But there is this other nail, "need", that could stand a blow or 2.
You (member of this economy dripping with consumers) need some discipline? Maybe you don't think so, but your peers (imagine you have peers, you money managers!) have other ideas. Your superiors (suspend whateveritwas you money managers and imagine you have superiors!) [the chances a HF manager is reading this?...zero.] think it is in the country's (a variation on "our" --a stone's throw from "we" and all the referential duplicity as pounded out above) best interests...to bestow upon yourself some restraint. Not indiscriminate punishment, but measured corrective procedures designed to restore good government and eradicate waste and mismanagement. [Like this, you lettuce heads.] And of course, nail #3, "recessions".
Ok, I'm sucking wind...blow back for all you're worth.

[anne]

Sweet NN,

I have no idea what you are blathering about, but blather on. Of course, you could always document the absurd claim.

" ---- supports valueless activity as long as someone gets a job out of it?"

Yeah; nothing gives less value to nothing than building and living in, say, a home. Duh.

[anne]

Sarah:

"Thank you for this voice of sanity-- though I doubt it will be heard over the outraged squeals that are sure to follow..."

Thank you for being prescient, Sarah.

[Lafayette]

Knot: The recession is baked in the cake already - we're just waiting for the "ding" from the oven timer.

How poetic.

Were economics just as easy as a cookbook, economists would be stirring the pot, wouldn't they?

[Winslow R.]

"The blame, if there is any, goes to those who
actually thought you could reflate given the
pressure globalization was/is exerting on wages.
That was a truly monumental blunder, but I
do believe it was an honest mistake...or maybe
wishful thinking based on rear view mirror driving."

I'm one of those that still think it is possible given the unlimited ability to print money.

My guess is the call is still a bit early and there is always the possiblity we end up with a ruling class with similar intentions towards deflation as those in Japan. My guess is the Japanese 'solution' would not work very well here because of differences in our societal values would result in too much pain for a large sector of society.

[save_the_rustbelt]

We don't "need" a recession, but I think we are going to get one.

I'm no economist, but the history of my adult life suggests some credibility for the "hangover" theory.

I have a similar theory called the "stupid money" theory. When investments are made just to keep money moving and people working I see a recession coming, and have been right the past three times (one sign of "stupid money" is when the fifth motel is being built at the I-75 interchange).

The construction of condos and housing in certain boom areas also suggests "stupid money." Ask any builder these days.

Assuming that recessions are inevitable, the more important questions is "what should the response be?"

[kharris]

Krugman didn't bother to point out that just about the only function performed by adherents to Austrian economic thinking is to accuse others of not knowing enough about Austrian economics or not giving Austrian economics enough weight or ignoring Austrian economics. Rather than beginning any discussion "The Austrian school is of the view that..." nearly every introduction of Austrian economics into a conversation bings along the lines of "your lack of understanding of Austrian economics..." or "if you had bothered to learn any Austrian economics..." It seems to be a cult-like characteristic, perhaps the Austrian school shibboleth.

[anne]

K Harris:

"The Austrian school is of the view that..." nearly every introduction of Austrian economics into a conversation bings along the lines of "your lack of understanding of Austrian economics..." or "if you had bothered to learn any Austrian economics..."

[Precisely; and an early reading was enough to have me blessing my lack of Austrian understanding.]

[david]

" ---- supports valueless activity as long as someone gets a job out of it?"

Anne: Yeah; nothing gives less value to nothing than building and living in, say, a home. Duh.

Response:
What do you mean? A lot of the houses that have been built externalize big costs onto society, in any case. Crap houses in crap subdivisions aren't necessarily good for anybody.

But the valueless activity that I see is the spinning up of home prices based on a ponzi scheme -- some people got rich, will have cashed out, and will pay no price, for skimming lots of money off the upturn, and their activity has been valueless from society's point of view. It's a real problem.

[foo]

I have to take issue with the idea that the people writing the rules were doing it in good faith for the general benefit of the entire population.

All the decisions made in 2002-2004 that have caused the meltdown now were done to win elections. End of story. And since the people making the decisions were extremely bright and savvy, I have no doubt they knew exactly the risks they were taking with the economy by making those decisions.

The bottom line is that they didn't care, as long as they won, and as long as they and their buddies could protect their power and wealth. After all, when the meltdown comes, as it has, it's only the little people that get hurt. The rich and the powerful can mobilize all the resources of the state, as they have, to make sure that they escape intact.

[calmo]

Ok, is it safe to assume kharris is not a member of the Austrian school? She's no Hayekian, but maybe a neoHayekian which is so unpronounceable...let's make it "kayakian" and print a few T-shirts...picture of a canoe with a broken paddle maybe...bound to sell a few to humor deprived economists, no?
With all due respect Madam, PK's opening line is:A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle--a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. which is about as "pointy" as you can get, no?

[wjd123]

I don't mean to absolve those who committed fraud, etc., nor do I mean to absolve those who did fall down on the job - the rule makers and the ratings agencies - from any responsibility for the outcome. But I doubt that the people writing the rules intended to cause a meltdown, and it's possible they did the very best they could with the information they had. And it can be argued, credibly, that ratings agencies simply responded to the economic incentives that were in place (i.e. responded as expected to being paid by those they were rating).

We made mistakes in the regulatory environment, no doubt about it, and I hope we learn and fix the problems....Mark Thoma

If Mark Thoma had written that "it's possible that the people making the rules did the very best they could considering the powers they had arrayed against them--Bush appointees, republican ideology, and the money of business lobbyist going to Congress"--rather than "the information they had" I'd be more inclined to agree. And, yes, it can argued "credibly, that ratings agencies simply responded to the economic incentives that were in place" but not that regulators weren't informed of where such a conflict of interest might lead. No, that's not credible. Not with Arthur Anderson's cold body so near.

I don't think the mistakes made in the regulatory environment were largely caused by a lack of information and to imply that they were is to absolve them of blame.

[Robert Powell]

It's instructive to read the paper by John Sterman, Director, MIT System Dynamics Group, http://web.mit.edu/jsterman/www/, on "The Long Wave Decline and the Politics of Depression." See list at http://esd.mit.edu/esd_books/sterman/sterman_publications.html.

Krugman doesn't understand, and therefore dismisses, the very real dynamics.

I have excerpts from Sterman's paper in "A Systems Thinking Perspective on Manufacturing & Trade Policy" at http://www.exponentialimprovement.com/cms/fostermfg.shtml.

The concept of a "long wave" as described by Sterman is hardly "intellectually incoherent" and it's not that "bad investments in the past" bring about "the unemployment of good workers in the present." They weren't "bad investments."

It's that the rational decisions in the past at a time of inadequate supply (e.g. after WWII) led to creating the capacity needed to fill the "bathtub" of goods and create the needed supply.

Inevitably, the greater capacity needed to fill the tub compared to the capacity needed if the tub were full and the system were in steady state, leads to overflowing the bathtub with excess supply.

On the upslope of the long wave overcapacity is absolutely required to "fill the bathtub" and there should be investment incentives. On the downslope, there is overcapacity and there should be wage incentives ... decreased taxes on wages to increase demand as well as increased taxes on investment returns to discourage investment and the creation of even more supply.

This doesn't mean that bubbles aren't created by policies that lead to over-leveraged speculation. In the dot-com bubble the Fed should have raised margin requirements instead of interest rates. In the housing bubble regulations should have prohibited no down payment, interest-only loans and the like.

While there has been much speculation, some people who wanted a home took advantage of the easy lending in good faith (not speculating) and then got trapped when the Fed raised rates again. It's too bad they'll be punished along with the speculators hoping to flip properties for quick profit on the upslope of the bubble.

[Winslow R.]

wjd123 wrote: "I don't think the mistakes made in the regulatory environment were largely caused by a lack of information and to imply that they were is to absolve them of blame. "

Sorry Mark and Anne, I agree with wjd on this one. The system is tilted towards the well to do. There are ways to remove the systemic tilt that Krugman and Thoma are not exploring beyond tinkering with the regulatory framework.

Remove the tilt then explore how to regulate it.

[baileyman]

As a quick overview, once as an analyst of essentially every public mortgage company I got to meet most of the managers, lots of the bankers, and lots of the investors. This is shark infested water.

At one time so-called subprime was a mom and pop business but began to get large in the late 80s. Household and Beneficial had made it large before then. I suspect the nusiness grew in tandem with the stagnation of real median income, but I can't show it.

Household and Benny were like training grounds for a new breed of mortgage banker. The game there was to get a mark in the door and then sell them some kind of debt. Didn't really matter what. Or how big. Now that they were on the line, the game was to walk them up increasingly larger deals. Every deal had a cash payoff to the loan officer. The fee was financed into the new and larger deal. The obvious thing for the lender was to keep flipping the borrower for fees. And they did. Until one last flip when the guy would bust and the company would have a writeoff. The company, not the loan officer.

H&B operated off commercial paper and other debt. Securitization made it possible for legions of lenders to start their own shops. They operated just the same. Sometimes the game would come to an end. Then they'd fold shop, vacation, get organized for the next cycle. There was never any value in the businesses, but plenty of value in the fee stream for insiders.

But securitization brought in a new class of sharks, the bankers, and they were smarter. In meetings with the lenders the bankers were always the smartest guys in the room. Still are. Mozillo included.

The banker motive is just the same. Get your mark on the line, get your fees in cash, walk him up to bigger and bigger deals. Until one last deal. Securitization allowed the bankers to sell unprecedentedly large deals for huge fees and boilerplate documentation, little work. the best business possible. But they knew, and they still know, that the same way the H&B lender destroys his mark, so do they the mortgage businesses. There is nothing accidental about this business. The destruction is intentional.

Really, this is an exercise in exploiting the legal system to force people to pay you large amounts of money. I suppose there will always be such opportunities as laws are changed and similar businesses spring up with new scams. This particular one should have been closed up many years ago. But it appears it will continue. You can be sure the sharks are busy planning for the next cycle to start.

I'm surprised anyone would consider that this kind of process would be worth preserving for the sake of a few people who actually benefit given the millions harmed and the many destroyed.

I'm surprised anyone would object to reducing the number we call GDP were the entire business to cease.

What's needed? Some way to restore the innocents who believed that the market produces a fair price, especially the first time buyers of the last 10 years. Some way to allow the full measure of losses to be realized by the speculator portfolios. Some way to bring a corporate death penalty to the operators and their bankers, you know, where the business assets are seized and the charter canceled.

The dilemma is helping the innocent without bailing out the lender.

[Not an Austrian]

It's not that we need a recession, but that if we do not control the current financial system which is built on exploiting the flaws in the system rather than analysis of business value, we will end up with a depression. The real issue is that it's probably better to have a nasty one to two year recession now, then to keep propping up a bubble that will give us a brutal 10 to 15 year depression later.

Think about the truly wild facts that have come out:
1) Bankers never expected to have to honor their guarantees of commercial paper.

2) Highly leveraged hedge funds never expected that they might have to write down the value of the CDOs they hold.

The only explanation for this behaviour that is totally oblivious to the downside risks of what they are doing is that these financial institutions are counting on being too big to fail and thus focused completely on short-term profits.

If the Fed does not choose to play the disciplinarian parent to the financial system now, you can be sure that we will all be forced to pay the price for our out-of-control siblings later.

[ken melvin]

Outstanding Bailey. And, there were co-conspirators. Lots of them. TV hyped buying while you still could. So did newspapers. Not just with ads, but also with commentary in the press and on TV news show. Realtor types appeared on news shows and talk shows. All these continued, even after things had obviously began to turn sour. Carny stuff.

[NowhereMan]

The best way to avoid a hangover is to keep drinking...

[Renay]

Sure, cut interest rates, and make it the next Fed chairman's problem.

Easy money conditions cannot last forever. It all catches up.
Greenspan took the easiest way out. Let's hope that Bernanke comes up something more creative than a Fed Funds rate cut.

Perhaps another drop in the discount rate would provide more stability were it is needed rather than bailing out out the reckless borrowers...

[wjd123]

Dean Baker over at "Beat the Press" has a different take in "The Unreported Wall Street Bailout." He says that 100,000 people buy new homes every week. Bailing out Wall Street with lower interest rates reduces the cost of carrying its bad debt which in turn gives it more time to unload overvalued property on "suckers," thus transferring much of their loss to new home-buyers.

It is not the Fed’s job to protect the financial industry from its own mistakes. As Greenspan and Bernanke said repeatedly in response to questions raised about first the stock bubble and now the housing bubble, the Fed can deal with the consequences of the collapse of financial bubbles. I’m skeptical about how well it will be able to deal with the consequences of the collapse of the housing bubble, but the Fed certainly has no business deliberately propping up financial bubbles so that more informed investors can recover from their mistakes. (In this respect, the Fed’s decision to encourage the use of mortgage backed securities as collateral on loans was completely improper. It should not have been giving its seal of approval to bad debt – I take back my earlier more benign view of this action.)

After having largely neglected to report on the growth of the housing bubble over the last five years, the media should start reporting on the losers in this bailout story. If the Fed can give the big Wall Street boys the opportunity to save themselves by unloading bad debt, then it just means that others will be the ones to eventually pay the price. The media should make it clear that bailing out Wall Street is not win-win; it is a win for Wall Street where some sucker down the road takes the hit.

http://www.prospect.org/csnc/blogs/beat_the_press

[im1dc]

Who Should Pay the Price for the Popped Real Estate Bubble? by Mark Thoma

Here's the essence of Thoma's economic theory:

"We don't need a recession. If the Fed determines an interest rate cut is needed to keep the economy moving toward full employment, then it shouldn't hesitate to implement the policy because it believes it would send the wrong signal to financial market participants. I hope we don't get so caught up in our zeal to make sure people learn the right lessons from all of this that we allow "bad investments in the past" to bring about "the unemployment of good workers in the present.""

Here's Krugman's theoretical two cents:

The Hangover Theory, by Paul Krugman:

"...the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality--with policies that encourage people to spend more, not less...."

I have argued previously that the "recession" question is invalid on its face b/c a quick look see reveals that Bush's US Treasury and Bernanke's FedRes are following Thoma's and Krugman's advice to fight a looming recession with "liberality--with policies that encourage people to spend more, not less..."

The reality is that the mortgage problems are huge and so riddled with fraud, over valuations and hype, that a money infusion can't fix it. Bad investments must go belly up to establish real value.

This is the reality that has intruded upon the financial markets (worthless CDO's with more to come) and the following is one RESULT: (be sure to read the entire article available at the link)

Ken Lewis as a modern-day Morgan
Commentary: Has Bank of America's CEO saved the credit markets?

By David Weidner, MarketWatch

Aug 28, 2007

"NEW YORK (MarketWatch) -- Sentiment is growing that Bank of America Corp.'s Kenneth Lewis may have won a place in the pantheon of great Wall Street titans by using his financial clout to help the country avoid economic ruin."

The B. of A. move comes exactly a century after J.P. Morgan -- back then, the man and the bank were the same -- helped stem the Panic of 1907. That year, depositors made a run on two U.S. banks. Morgan responded by convincing U.S. Treasury Secretary George Cotelyou to inject $25 million into the banking system. Sound familiar?

Morgan also created a $3 million pool to save Trust Co. of America. Responding to pleas from the New York Stock Exchange, Morgan, leading a consortium of bankers, pledged another $25 million to back the exchange. He also bailed out New York City by backing a $30 million bond issue.

In today's terms, that would be about $600 million for the banking system, $71 million to Trust Co. and a $631 million bond issue. Morgan didn't put up all the funds, but he organized the relief.

His reward? Morgan helped the economy, and in turn his own assets. Brokers on the floor of the NYSE cheered his action to help the exchange so loudly that he could hear the roar from his office across the street at 14 Wall St. A thankful Washington allowed him to buy a railroad worth about $16.7 billion today for $1.1 billion.

This leaves Lewis as more of a shrewd opportunist than patriotic investor. He and B. of A., after all, have been pining for a piece of Countrywide for more than five years.

Lewis legacy

Not only did the executive get the stock at a deep discount of nearly 50%, but also the shares pay a 7.25% dividend. What's more, the investment immediately returned a paper profit of more than $400 million after the deal was announced and Countrywide's stock soared.

"Those four (BofA, CITI, J.P. Morgan Chase, Wachovia) going to the discount window is like someone from the Upper East Side going to Wal-Mart," Geisst added. "They were probably fronting in the marketplace for an institution that was really in trouble."

link: http://tinyurl.com/2syzdg

What happened is that BofA used the Fed Window to borrow and spend $2 B to buy up a piece of Countrywide Financial which then used the cash to fund its mortgage ops.

The FedRes helped Wall Street scoop up a piece of Main Street.

[James Killus]

When the stock market bubble burst, there were at least a few names attached to malfeasance, like Skilling and Lay, people who had obviously committed fraud or malfeasance of one sort or another. When the electric power scam on California made it into the news, there were some tapes with guys making fun of taking money from old ladies, and, lo, there was some Enron action there, also.

Not that these ever did either the Enron employees or the folks they bilked any good.

Does anybody here have an idea for a poster child for the bad old meanies what did this to everyone? Does anyone have a list of indictments, other than "they knew what they were doing," and "they should have known better?"

It looks to me like the folks who were selling bad paper on the way up are now buying distressed properties on the way down. Never play poker with a man named "Doc," got it? And the best con men always know how to cool the mark. One of those ways is to set up a patsy or a fall guy. Do you really think you're going to get the right guys, when you don't even know their names? "Doc" isn't his real name, by the way.

[wjd123]

I seem to be having pronoun agreement problems today. Sorry about that.

[im1dc]

Additional history, perspective and more evidence of Wall Street's manipulation of markets

The run on Countrywide Financial was caused by the word "bankruptcy" used by a widely read Merrill Lynch financial analyst on page 4 of his report on CW knowing full well that it was inappropriate and would cause a stir on Wall Street occurring as it did right smack in the middle of the Subprime Mortgage crisis.

CW is the nation's largest Mortgagor and not primarily a Subprime Mortgagor. The published remark caused a run on CW deposits, forced CW to borrow its entire $11.2 Billion credit line and b/c of the subprime mess CW has been unable to profitably sell its mortgage packages (CDO's) to investors.

Is this Lord Keynes "Hidden hand" or was it deliberate hand?

If Bernanke's FedRes had come out vocally in support of Countrywide they could have stopped the run but Bernanke and company did not deign to help CW only Wall Street Money Center banks.

Remember Jim Cramer's rant on TV?

Makes one wonder just who the FedRes was trying to help doesn't it?

Not the home owner in crisis, Countrywide Financial or the Subprime lenders obviously. They are letting them bleed to death, i.e., 'can't interfere with the working of the market'.

But they did hit the panic button for BofA, CITI, J.P.Morgan Chase and Wachovia.

Why is this Krugman's "liberality" and Thoma's "we don't need a recession"?

Let's just call a spade a spade and call this Corporate Welfare for Wall Street Money Center banks by the FedRes.

Why is the US Tax Payer on the hook propping up failing businesses just to hold up RE over valuations?

Isn't that socialism or communism?

What else has Merrill Lynch been up to? Glad you asked:

Citi, Lehman Brothers, Bear Stearns downgraded at Merrill

By Simon Kennedy, Aug 28, 2007

"But given the risks, we feel the need to be more selective," Merrill said. Merrill added its top picks in the sector are Goldman Sachs
and Morgan Stanley because of their business mix and geographical diversity."

link: http://tinyurl.com/2rgak3

Merrill Lynch is more than a broker. They also make loans. They are a mortgagor. They are a subprime mortgage mortgagor. They fund Hedge Funds. Parts of ML are Hedge Funds. They manage money. Etc.

Perhaps it is time for the FED GOVT to create a modern day Glass-Steagall Act to keep the different parts of large financial institutions like Merrill Lynch from putting other assets at risk.

For those who do not know of Glass-Steagall:

link: http://www.investopedia.com/articles/03/071603.asp

IMO The question here is not whether "we need a recession" or "liberality" by the Govt to prevent recessions it is whether or not capitalism's markets ought to be allowed to work to wring out excesses and readjust pricing to realistic valuations.

There was a time not long ago that alone the valuation of the Royal's Palace in Tokyo was in excess of the total valuation of all RE in California.

That was total and utter nonsense and ultimately recognized as such. In fact, it called the top of the Japanese market.

Why when this same sort of valuation absurdity occurs in USA RE economic theoreticians like Thoma and Krugman don't recognize the necessary adjustment to valuation just escapes me.

Or maybe both Thoma and Krugman actually believe and can argue cogently that even the cheapest home in Los Angeles California is worth no less than a $500,000 premium to the average home sold in the USA, i.e., $750,000 versus $224,000 and that the LA RE ought to appreciate 8 to 12% per annum forever.

I dunno, that seems to me to be even more absurd than the Japanese Royal Palace story.

[im1dc]

I just saw this in the NY Times:

Editorial

What Looks and Sounds Like a Bailout?

skipping

"But even if the Fed succeeds in managing the crisis, its actions stir questions anew about the longer-term sustainability of the debt-fueled state of the American economy.

And they are yet another reminder that even as officials are quick to try to counter threats from Wall Street, they have yet to make any real progress toward heading off the coming wave of foreclosures, which could rock the markets as early as this fall and create a social crisis on top of a financial one.

Bailouts are tolerable only if the help they provide is in the broad public interest, and if they’re followed by punishing wrongdoers and imposing new rules and procedures that help to ensure that the same problems will not happen again. The Fed is playing out its role in the bailout, but the Bush administration and Congress have yet to step up to theirs."

link: http://tinyurl.com/yp95w6

This fairly sums up my issues with the FedRes actions.

[habitant]

The conclusion fails to recognize that a change to the Fed Funds rate is an inherently political decision. What happens when the Fed cuts by 25 bp on Sep. 18th and the market drops 2 percent because the whiners on Wall St. don't think it goes far enough? The economic models say one thing, the psychology of the market says another--that was the impetus for most of Greenspan's emergency rate cuts. Stamping out moral hazard requires policy makers to inflict pain--few ever do.

[worker]

I find it funny that the left is now on the side of the suv driving exurbanite living a consumerist lifestyle? I guess that's ok in your world as long as you go on welfare? Or is such consumption OK as long as someone else pays for it (other than relatives, trustfund baby)? You leftists live in a highly refined and idealistic world. Is the shystey nouveau riche real estate agent/ mortgage broker deserving of gubmint help, or will they need to join a union first? It must be tiring keeping up with the latest fads.

Yes, we should have regulated on the way up but the horse is out of the barn here. The fed can't simultaneously ignore asset valuation as a driver of inflation (as it did on the upside) and then intervene everytime an asset drops 10%. As the NY Times editorial bailouts are tolerable if they are in the broad public interest. Stealing from savers to reward spendthrifts and to inflate property values is not in the public interest.

Unless of course, you are an evil babyboomers defining the public interest as any policy that supports your egomaniacal consumption while heaping further debt on your children. Or a marxist who really thinks the gubmint should buy everyone a house.

Ultimately, I think there will be a muted reaction to the foreclosure wave- the vast majority of "victims" facing foreclosure recognize that their own greed or stupidity in their predicament. Also, it is hardly a depression era crisis since most of the victims who are last 3 year purchasers aren't actually losing anything since they put nothing down in the first place. Even with a traditional mortgage, the early year principal payments are minimal. What is someone who put nothing down really losing other than an unrealistic (possibly delusional) expectation of future riches? Ever hear the expression, "hate to burst your bubble!"

To the illiterate and innumerate lemmings, after you get on your feet give me a call. I have some great shiny objects to sell you- they're not making anymore of them and they're guaranteed to increase in value foreover!

PS. Apologies to real victims of fraud that you are being lumped in with get-rich-quick schemers and illiterate/ innumerate lemmings.

[Lafayette]

worker: Stealing from savers to reward spendthrifts and to inflate property values is not in the public interest.

What savers? Find one in today's America before making such a claim.

They were on the endangered species list, last time I looked.

[carmelo cortes]

I read many krugmans´s books and they are good. Nevertheless I disagree with his despise towards austrian economics. Us economic macro is in really bad shape but this has been going on since last 10 years. This will be not a normal recession but a secular one, sooner or later parties have to be paid. I wonder what the sum of 44 billion debt is financing now compared to 24 b. in 2001. Sure there is an excess of debt that will only extinguish with default or inflation. The debt can be erase but the assets prices will decrease to normal levels causing a secula recession if not depression. No other way out.

[wimpie]

"read many krugmans´s books and they are good. Nevertheless I disagree with his despise towards austrian economics. Us economic macro is in really bad shape but this has been going on since last 10 years."

Yea, I remember his missives on how japan should exit their liquidity trap......print, print, print.(sounds like Bernake, ehh?) Which of course is a 180 from what an austrian would recommend.....stop printing and let the market come to an equilibrium.

Well, guess what? They printed....they failed...no wonder Krugman doesn't like austrians.........Who wants to be proven wrong?

[poszi]

I think Americans are obsessed with Great Depression. They think that everything should be done to cure the symptoms of this Depression: deflation. And, by induction, lowering interest rates can save from recessions. I think it does not matter. There were a lot of inflationary depressions around the world (early 1990s in Finland is a most recent example in the developed world) and a lot of examples of inflation not curing anything (forgot 1970s?). I think with the "helicopter theories", there is a great chance that Bernanke will learn in practice how wrong he is by creating inflationary depression or hyperinflation. I also would recommend reading a commentary on this subject by Robert Shiller.

It is not that "we need recessions" as a matter of justice. Well, we may need recessions to protect from future moral hazard but more important is that recessions are, as written also above, baked during booms. This boom employed a lot of people into nonproductive activities. Getting rid of this activity is good. This part of GDP should have never be made. Some was even worse than nonproductive, it was waste like taking resources to build McMansions in the middle of nowhere. That's why some "recessions are good". These people instead of flipping houses and selling Ponzi mortgages that required constant refinancing and never ending house appreciation could do something productive. If we stop this curing process, we simple prolong the illness.

[Lafayette]

All the above comments traipse around the nub of the debate. Which is, "Do we ignore recessions or do we fight them".

The Economist article, cited, which prompted the debate is correct. They should be allowed to happen an antiseptic economic cleansing. But, neither are Krugman/Thoma wrong, recessions should not be allowed to continue unabated.

Deftness in policy would let them happen for the "organic restructuring" in markets to occur, then reflation (monetary / fiscal) will induce consumers into spending once again.

The nub is timing. How long should a recession last? It must last at least two quarters to be recognized a bona fide recession -- but six months of high unemployment (anything beyond 5% in "safety-netless" America) is unacceptable. A person can be out of house and home in 30 weeks, if unable to pay debt, particularly realty debt.

Now, presume that you are either the PotUS or the Fed Chairman. How do you manage reflation? You (PotUS) cut taxes, which will enhance almost immediately disposable income (in a pay-as-you-go income tax system) ... or you (Fed Chairman) cut interest rates that will have also an immediate effect?

Which is better? We simply don't know, which is why we do both. The consequence often, however, is to start reflation of the next bubble -- which happened in the present case of sub-prime lending abuses.

Of course, the next bubble in asset pricing requires a healthy dose of "exaggerated exuberance". But, not to worry, American finance marketeers have it in abundance -- for a clientele that is always looking eagerly for the "quick buck".

It's in the nature of the beast. So, tame it. How?

By regulating closer how people sell debt products to a naive American clientele. It's called Truth in Lending, and requires a balanced detailing of both Prospective Gain AND its Coincident Risk -- with the application of Lending Rules that vet those prospective clients who do not have the financial wherewithal to assume debt.

Anything less than a totally informative proposition for assuming personal debt is criminal fraud. And, those who perpetrate criminal fraud deserve the consequences.

NB: Fraud: wrongful or criminal deception intended to result in financial or personal gain. Deception: the act of deliberately misleading or misrepresenting the truth (of a thing) to give a mistaken impression

[reason]

Wimpie...
read my earlier comment - Japan's problem were that it in fact didn't just print money, it ran large Bond financed deficits. And how do you know things would not have been much worse if it didn't do what it did (1930s anyone)?

says...

Pozzi...
the problem with your argument is that many jobs created in a boom are non-productive, but no job is less productive still. And normally firms doing unproductive work go broke - only ever accelerating finance (i.e. hyper-inflation) can stop unproductive businesses going broke. If they can't produce something useful, their expenses will exceed their income and their bankers will stop lending to them. The economy is complex enough that some industries will be growing and some shrinking all the time. So the real danger is runaway psychology of one sort or another (self-filfulling optimism or pessimism). The evidence of the last 40 years is that fine-tuning in general works.

That doesn't mean, I don't think we have big problems at the moment. But the problem is institutional (perverse incentives in financial markets - misuse of limited liability status and leverage - and manipulated international finance) not necessarily simply macro-economic.

[reason]

The last comment was also mine.

[worker]

"the problem with your argument is that many jobs created in a boom are non-productive, but no job is less productive still."

I think call center subprime mortgage broker falls into the category of "less productive than no job"- getting paid to create problems for the rest of society.

[KnotRP]

No job is truly better than hooking anchors on a short chain onto other swimmer's ankles, even if you count stealing their inflatable raft as productivity.

[Lafayette]

reason: But the problem is institutional (perverse incentives in financial markets - misuse of limited liability status and leverage - and manipulated international finance) not necessarily simply macro-economic.

The Gotta-Have-It-Now Generation

The above is true, but it seems to exculpate lenders of all responsibility in this mess. "Caveat emptor" is not a bad dictum, particularly in the context of credit lending in a nation hell-bent on credit purchasing. But, when people are too naive to undertake the most simple precautions as regards credit financing; what then?

How did we get this way? That is, little savings and large personal consumption most of which is financed by credit? All by our little selves. Consumers do not understand when they are spending beyond their means -- they have to get walloped by a repossession for nonpayment and reality sinks in.

Lead-head tried to dampen this activity by closing the door to recidivist bankruptcy. That could be a positive factor in chilling out such repetitive bankruptcies.

But, perhaps something a bit stronger is also necessary, something that requires full disclosure of personal debt in the support documentation for a mortgage/loan -- as is the current requirement for government guaranteed mortgages.

Whatever the solution, it must come BEFORE the credit is approved, not AFTER.

Press releases seem to indicate that such cool-headedness is becoming once again conventional of lending institutions -- now that the horses are all out of the barn.

It takes a crisis of gigantic proportions for common sense to penetrate some skulls. Why does this repeatedly happen in financial (debt/equity) markets on the US side of the pond? Anyone have a post-WW2 record of such a financial mess starting in Europe and infecting world markets in one fell swoop?

That's two significant financial crises too many in just seven years ... both seriously diminishing the credibility of US financial markets.

Let's hope it's not a trend, but the inability America's financial establishment to control themselves can only undermine completely its long-term financial stability. When that is lost, it's gone for a long, long time.

Greed is NOT good. The pursuit of profits at any expense is sheer folly.

NB: A recent BBC report suggested that the world's financial center is gradually shifting from New York to London. When this is finally recognized as "having happened", let it surprise no one.

[Lafayette]

Typo: "The above is true, but it seems to exculpate lenders of all responsibility in this mess."

Should read: The above is true, but it seems to exculpate borrowers of all responsibility in this mess.

[ken melvin]

Lafayette, their tv news person, their newspaper, their wall street show, ... all insisted they should buy before it was too late; even when it was obvious to all that the bubble was about to break.

E.g.:

Spoke with a lady who runs an upholstery and hires an illegal Chicana to disassemble. The Chicana, works three jobs, is illiterate, both reading and math, and speaks no English. Her family pools their collective wages to live in an $800/mo apartment in one of Oakland's seedier parts (husbands disabled from an injury because he had no medical attention. The family just bought a house in Oakland for $400k. The payments will be $2.5k/mo.

The group doing this seems to be Su Casa. I understand they advertise only on the Spanish language TV Channels.

I sent this story to virtually all the SFChron's reporters. I didn't get a single response. They are all comppromised.

[Lafayette]

km: I sent this story to virtually all the SFChron's reporters. I didn't get a single response. They are all comppromised.

And, I think it is only the tip of the iceberg.

I see on French TV in-depth reporting (from around Europe) about the US that is rarely, if never, seen on the main news channels in the US.

One would think that, at least, the public broadcasting channels would pick it up. But, no.

So much for freedom of the press. Junk it with a couple of those other freedoms we thought were a birthright.

[Monkey In Chief]

There's a huge difference between the Fed cutting interest rates because it sees the economy dropping under full employment and the Fed cutting interest rates because it sees asset prices falling.

I'm strongly opposed to the Fed paying any attention to asset prices. If home prices, the stock market, or any other asset class craters, the fed should not react or their is a Greenspan / Bernanke.

If you believe the Fed should cut interest rats to prevent housing prices from falling, the converse is also true. The Fed should (have) raised interest rates sharply to prevent housing prices from rising too quickly. Managing asset prices is a two way street. I have not seen *ANY* pricing model that can justify housing prices. Rent ratios and income ratios are way out of line with historical norms. The only logical conclusion is that housing prices need to come down so ratios are inline with historical norms.

It's disingenuous of Krugman not to point that real estate boom fed a lot of non-real estate spending financed by HELOCs. There's no way that can continue forever regardless of what the Fed does.

[Lafayette]

MiC: The Fed should (have) raised interest rates sharply to prevent housing prices from rising too quickly.

I agree that this is not the Fed's concern. But, it is a macroeconomic concern nonetheless when asset-revaluation becomes hallucinatory (i.e., bubble-like). Such speculation is rarely constrained and when truly excessive it tends to impact the economy negatively.

If we are to prevent this in the future, then we must tinker with short-term personal gain derived from either equity or secondary-housing resale. Any realty, other than one's personal residence (their house&home), should be submitted to a serious short-term capital gains tax -- not to stop it, but to mitigate frenetic price rises (and the propensity for indebtedness) to profit from them.

There is a moral imperative involved: Why should people benefit from wild speculation under circumstances that can lead to a generalized financial dysfunction? Speculation is a bona fide risk investment. But, its justification is not binary, that is, a simple choice between "yes, we'll allow it / no, we wont".

It is conditional, because the consequences of too much speculation -- it has been seen -- has an impact on all, whether we participate in that game or not. Speculative frenzy is NOT normal human behaviour, unless it is allowed to be.

NB: moral (adjective):
1 concerned with the principles of right and wrong behaviour and the goodness or badness.
2 adhering to the code of behaviour that is considered right or acceptable.

[KnotRP]

This was in my bookmark set of things to revisit, and point out:

> Were economics just as easy as a cookbook, economists would be stirring the pot, wouldn't they?

Economists have proven themselves to be non-useful for anything other than sell side work.

Too bad the folks who neglect maintenance are never expected
to pay the full cost of their failures.