Paul Krugman: Success Breeds Failure

When duct tape won't do the job, it's time to break out the baling wire. But eventually, if real repairs aren't made, the whole system can come apart at the seams:

Success Breeds Failure, by Paul Krugman, Commentary, NY Times: Cross your fingers, knock on wood: it’s possible, though by no means certain, that the worst of the financial crisis is over. That’s the good news.

The bad news is that as markets stabilize, chances for fundamental financial reform may be slipping away. As a result, the next crisis will probably be worse than this one.

Let’s look at the story so far.

After the financial crisis that ushered in the Great Depression, New Deal reformers regulated the banking system, with the goal of protecting the economy from future crises. The new system worked well for half a century.

Eventually, however, Wall Street did an end run around regulation, using complex financial arrangements to put most of the business of banking outside the regulators’ reach. Washington could have revised the rules to cover this new “shadow banking system” — but that would have run counter to the market-worshiping ideology of the times.

Instead, key officials, from Alan Greenspan on down, sang the praises of financial innovation and pooh-poohed warnings about the growing risks.

And then the crisis came. Last August, as investors began to realize the scope of the mortgage mess, confidence in the financial system collapsed. ...

The Fed’s efforts these past nine months remind me of the old TV series “MacGyver,” whose ingenious hero would always get out of difficult situations by assembling clever devices out of household objects and duct tape.

Because the institutions in trouble weren’t called banks, the Fed’s usual tools for dealing with financial trouble, designed for a system centered on traditional banks, were largely useless. So the Fed has cobbled together makeshift arrangements to save the day. There was the TAF and the TSLF..., there were credit lines to investment banks, and the ... barely legal ... rescue not of Bear itself, but of its “counterparties,” those who were on the other side of its financial bets.

It’s still far from certain whether all this improvisation has resolved the crisis. But it was the right thing to do, and for the moment things seem to be calming down. ...

We now know that things that aren’t called banks can nonetheless generate banking crises, and that the Fed needs to carry out bank-type rescues on their behalf. It follows that hedge funds, special investment vehicles and so on need bank-type regulation. In particular, they need to be required to have adequate capital.

But while our out-of-control financial system has been bad for the country, it has been very good for wheeler-dealers... They don’t want regulations that would stabilize the economy but cramp their style.

And now that the financial clouds have lifted a bit, the pushback against sensible regulation is in full swing. ... Maybe a Democratic sweep in November can revive the cause of financial reform, but right now it looks as if we’ll soon return to business as usual.

The parallel that worries me is what happened a decade ago, after the hedge fund Long-Term Capital Management failed, temporarily causing the whole financial system to freeze up.

Through luck and skill, that crisis was contained — but rather than serving as a warning, the episode nurtured the false belief that the Fed had all the tools it needed to deal with financial shocks. So nothing was done to remedy the vulnerabilities the L.T.C.M. crisis revealed — the same vulnerabilities that are at the heart of today’s much bigger crisis.

And if we don’t fix the system now, there’s every reason to believe that the next crisis will be bigger still — and that the Fed won’t have enough duct tape to hold things together.

Comments

[Wags]

Hedge funds embrace Obama, donate less to Clinton http://www.reuters.com/article/politicsNews/idUSN2635694020080226?feedType=RSS&feedName=politicsNews&rpc=22&sp=true

Same old Story, whether it HRC, Obama, or McCain, Money Talks.

[Winslow R.]

"and that the Fed won’t have enough duct tape to hold things together."

What does duct tape represent, money or political will?

Both are created out of thin air by various institutions and therefore have an infinite supply.

[Maxincalf]

"it’s possible, though by no means certain, that the worst of the financial crisis is over"

I'm confused. I thought that the majority of people in the US with terrible mortgages were still waiting for them to reset, with possibly catastrophic results. So how can the worst be over?

Can anyone help me on this one?

M

[David]

"We now know that things that aren’t called banks can nonetheless generate banking crises, and that the Fed needs to carry out bank-type rescues on their behalf. It follows that hedge funds, special investment vehicles and so on need bank-type regulation."

How do we regulate hedge funds based in Singapore or the Cayman Islands? Same with SIVs that are structured abroad.

[wcw]

'Baling' wire, as in hay bales. Wire will not bail you out of anything, trust me. I've tried.

Getting the small stuff right matters.

[Mark Thoma]

Thanks - fixed - should have caught that.

Something bugged me about it, wasn't sure what, so I Googled "bailing wire" before posting without thinking about it much - bailing is quite common, even as a business name - so I left it. Guess I should use a dictionary next time.

[Mark Thoma]

I was playing with a new toy. Don't tell anyone:

http://video.google.com/videoplay?docid=3749233262805726005

[Posted 3/29, CNN has been re-running it this weekend.]

[Lafayette]

Battle of the Economists?

Krugman (Press Article): Cross your fingers, knock on wood: it’s possible, though by no means certain, that the worst of the financial crisis is over. That’s the good news.

Rogoff (Bloomberg)``It is very hard in the middle of a crisis to know where to draw lines,'' said Harvard University professor Kenneth Rogoff, a former research director at the International Monetary Fund. ``They reduced the immediate risk of a crisis, but upped the ante of raising the possibility of a bigger crisis down the road.''

So, who's right?

My guess: With borrowing costs significantly reduced from 4.5 to 1.5 percentage points (from the same article as the Rogoff quote above here) credit agents (banks and other lending institutions) holding toxic waste have a considerably more breathing space for about six months.

This will allow them to figure out a way to separate the depleted from the re-enrichment possible toxic waste. Not all foreclosures possibilities may foreclose actually as the lenders will accept lower payments, perhaps even forgoing the balloon payment impending down-the-road or renouncing them if they have kicked-in. It is not in their interests to have the number of foreclosures increase, which simply makes potential buyers wait a bit longer hoping to get a better deal.

That market situation depends upon the economy as a whole and the economy depends upon public sentiment to spend. Is that sentiment retrenching as recent news indicates. Or is that downturn only temporary? That depends upon the media spin given to it.

The present news is uniformly bad, so what should anyone expect as regards consumer propensity to spend -- except a trip southwards. Still, American consumers are shop-till-you-drop addicts. They can also rebound quickly. I'm betting on this happening. Six to nine months, that's all it will take.

Right up to ... uh, about November. How odd, that coincidence ....

[Blissex]

«When duct tape won't do the job, it's time to break out the
baling wire. But eventually, if real repairs aren't made, the
whole system can come apart at the seams:»

But a bailout which is a monetary whitewash is not a bailing wire;
it is a free lollipop given to arbitrageurs to encourage them to
do it bigger next time.

Also, Krugman gets the analysis completely wrong, because he seems
to think that the current problems are new, when instead they are
the result of one of the oldest financial scams around.

The oldest and safest financial scam is (undercapitalized)
insurance: because it allows current management to collect a large
inflow of premiums to start with, looking like current management
are financial geniuses that are making huge profits and deserve
colossal compensation, and then when the insureds come to take
their payouts, that's a problem for future management, or in the
Republican paradise the USA is now, that's a problem for the Fed
to solve innovatively, with a chorus of economists praising them
all the way as the Fed recapitalizes those insurance scams using
public money and inflation.

Every time someone is allowed to start an unregulated insurance
business this is guaranteed to happen: take the premiums and run
is absolutely the norm. The beauty of insurance is that income is
front loaded and expenses are back loaded, and even dim players
can arbitrage that to great advantage.

«Eventually, however, Wall Street did an end run around
regulation, using complex financial arrangements»

Very very simple ones -- the genius of Countrywide and the
investment banks has been to turn their businesses into
unregulated insurance businesses, in fact but not in name, thanks
to "securitization". Turning what should be business risk into
insurance risk is what securitization does, as it replaces the
need to assess each risk into its own merit with the convenience
of having it assessed statistically by actuaries.

«to put most of the business of banking outside the regulators’
reach. Washington could have revised the rules to cover this new
"shadow banking system" [ ... ] - but that would have run counter
to the market-worshiping ideology of the times.»

But is is not a shadow banking system -- it is a shadow
insurance system. So there was no need for rules -- there are
plenty of good rules about chartering insurance businesses as
such, and then holding them to minimum capital requirements.

«And then the crisis came. Last August, as investors began to
realize the scope of the mortgage mess, confidence in the
financial system collapsed.»

That's not investors -- that's counterparties. Investors may
have started selling financial stocks, but the real trigger was
that counterparties started to realize that their own and other
counterparties capital was being wiped out by what were in effect
insurance claims not backed by sufficient reserves.

«rescue not of Bear itself, but of its "counterparties,"
those who were on the other side of its financial bets.»

Sure, but those counterparties were rescued on an insurance
basis. Most derivatives that have been blowing up are in effect
insurance policies. The risk being insured was the risk that the
value of houses would become lower than the value of the loans on
them, at a time where house prices were at historical heights.

«We now know that things that aren’t called banks can
nonetheless generate banking crises, and that the Fed needs to
carry out bank-type rescues on their behalf.»

No, not banking crises, insurance crises, and the Fed
is carrying out an insurance rescue by providing underwriting
reserves of last resort (or first resort actually).

«It follows that hedge funds, special investment vehicles
and so on need bank-type regulation. In particular, they need to
be required to have adequate capital.»

They need to have insurance type regulation when they
sell what are in effect insurance policies, and they need to have
adequate reserves indeed, like any sane insurance business.

Also, the ratings-for-sale agencies have in effect been
providing unregulated actuarial services for the securitization
business, and auditors have been happily accepting the fiction of
premiums turning wholesale into profits thanks to insufficient
provisions of reserves.

In an ideal world they should be severely punished for this,
or at the very least regulated as providers of insurance related
services.

But the 3 ratings-for-sale agencies and the 3 audits-for-sale
partnerships are too crucial to fail anyhow, so PARTY ON.

«But while our out-of-control financial system has been bad for
the country, it has been very good for wheeler-dealers... They
don’t want regulations that would stabilize the economy but cramp
their style.»

But of course! Cashing in premiums now and letting the Fed
underwrite the losses later thanks to the Berkanke Cds is a
fantastic business for WINNERS. it allows them not only to tunnel
out their own employers' capital, but that of their insurance
customers and that of the government.

«So nothing was done to remedy the vulnerabilities the
L.T.C.M. crisis revealed — the same vulnerabilities that are at
the heart of today’s much bigger crisis.»

But they are not quite the same: LTCM made the wrong bets on
their own. The (alleged) reason their counterparties had to be
rescued was that they had lent LTCM too much due to LTCM being
very opaque.

In the current case the problem is that bad insurance has been
sold, even more than that wrong business bets have been made (not
coincidentally), and the process has been entirely transparent and
even lauded and promoted by the government.

There is the argument that "hedge" funds are often just
insurance premium collectors and a lot of banks seem to have
chosen the same, only worse: place bets that are certain to fail,
instead of unlikely, collect premiums now and retire wealthy soon
thereafter.

[Blissex]

«I thought that the majority of people in the US with terrible mortgages»

A $500,000 mortgage is only terrible if it is on a $250,000 home, but it is a very profitable asset if it is on a $600,000 home.

The Fed's principal problem has been how to make sure that $250,000 homes sell for $600,000, and they know how to do that ("Fed*mart: always rising asset prices - always"): cheap mortgages.

«were still waiting for them to reset, with possibly catastrophic results.»

If you look at the Countrywide stock price, which seems to me to be a proxy for mortgage fraud:

http://money.CNN.com/quote/chart/charts.popup.html?symb=CPC&time=30yr

You may notice that the big rise in the stock price is coincidental with the great Greenspan Money Sale ("Fed*mart: always low interest rates - always").

Current Fed*mart interest rates are in deeply negative territory again.

«So how can the worst be over?»

Interest rates to large financial intermediaries at 2% nominal with 5-10% inflation? Check.

Policy statement that whoever lends to an insolvent threat to the financial system gets a free Bernanke CDS? Check.

What more do you want?

[Blissex]

«If you look at the Countrywide stock price, which seems to me to be a proxy for mortgage fraud: http://money.CNN.com/quote/chart/charts.popup.html?symb=CPC&time=30yr» Sorry about that, that was a typo, the link is: http://money.CNN.com/quote/chart/charts.popup.html?symb=CFC&time=30yr For comparison look at other proxies, Lehman's and Merrill's: http://money.CNN.com/quote/chart/charts.popup.html?symb=LEH&time=30yr http://money.CNN.com/quote/chart/charts.popup.html?symb=MER&time=30yr As always, mentally superimpose the Fed rates :-). For extra amusement, the stock prices of the ratings-for-sale companies: http://money.cnn.com/quote/chart/charts.popup.html?symb=MCO&time=30yr

[Blissex]

«There is the argument that "hedge" funds are often just insurance premium collectors»

A famous example of just that:

http://www.businessweek.com/magazine/content/06_03/b3967071.htm
«If 2006 is a quiet year for hurricanes, Greg Hagood stands to make a ton of money. But if more Katrina-size storms rip into the U.S., he and the investors in the hedge fund group he co-manages, Bermuda-based Nephila Capital Ltd., could get their shingles blown off.»

This might make sense if the fund is just hedging: it is in effect shorting hurricanes, and that could be a hedge if they are also shorting property insurance stocks.

But the overriding temptation is to assume that position un-hedged: if the hurricanes don't happen, the fund manager pockets 20% of that premium, and anyhow it has the premium's cash to make another leveraged play and potentially earn more for the manager again. Head they win, tails the fund loses.

The current trouble has happened because investment banks have been in effect selling insurance against house prices falling (in the form of CDOs and CDSes), with very attractive premiums, and very small reserves thanks to the ratings-for-sale and the audits-for-sale professionals that have endorsed the very small size of those reserves.

[swells]

Shouldn't we just assume that regulations will be subject to "end runs" any time it seems possible to those with a vested interest in such things? It's leverage itself that is suspect here. Has their been any attempt to find some level of leverage that is acceptable from a risk perspective? If that could be found out, then perhaps a maximum leverage level could be set in somewhat the same way that interest rate maximums are set. We have usury laws (and yes I know even those get 'end run' by payday lenders, etc.) so why not have financial irresponsibility laws of a similar ilk.

[Lafayette]

blissex: Very very simple ones -- the genius of Countrywide and the investment banks has been to turn their businesses into unregulated insurance businesses, in fact but not in name, thanks to "securitization".

What genius? Copycat genius? Fannie Mae or Freddy Mac have been doing it for a long, long time - monetizing their loan burden (the security having always been there, due to government ownership). Thereby allowing them to make even more loans.

So, what's the difference between them and sub-prime loans? Standards of quality in lending.

What's the solution? Apply solvency lending rules such as one third of net income (meaning less taxes and outstanding credit debt) as the monthly repayment and therefore also the lendable amount on a 20-year mortgage loan. In fact, ten would do -- since, on average, the younger set turn over their residence after 7 years.

And/or, a one-time-only preferential treatment for first-time residence buyers (citizens only). The "market solution" fouled up the game all by itself (with its immeasurable greed). It would be salutary to have a government based scheme take part of it away from them. Let'em learn the hard way.

This would also assure that innocent people get a chance at owning their own homes without being taken to the cleaners.

[blackswan]

It is unlike Krugman to disconnect what he perceives to be a Wall Street comeback with the deepening crisis on Main Street. He's applauding the Fed's taking in opaque MBS, that can't be marked to market, yet, at the same time, he's advocating for the regulation and transparency of hedge funds.

Regulating hedge funds won't change anything any more than regulating banks has. The investment and commercial bankers still get to be banksters. Anyway, sovereign wealth funds rock the world, and nothing will regulate them.

Presently, the Fed is doing everything in its power to prevent transparency. It will now add opaque bonds, backed by asset backed securities and credit card debt, to the hidden-valued, Bear Stearns mortgage backed securities it started holding as collateral during the JP Morgan bailout.

The Greenspan Fed (now with a different frontman, Bailout Bennie) has always been opposed to transparency. Greenspan and former Sec. of Treasury Rubin deliberately promoted this game of derivative liar's poker. Remember, Hillary has talked about bringing back Greenspan and Rubin as her economic advisors.

"Schwartz & Dash describe how former Fed Chairman Alan Greenspan, former Treasury Secretary Larry Summers and Rubin coordinated to undermine efforts by CFTC Chairperson Brooksley Born to impose greater federal oversight of OTC derivatives markets. They report: "On at least one occasion, Mr. Rubin lined up with Mr. Summers as well as Mr. Greenspan to block a 1998 proposal by the Commodity Futures Trading Commission under Ms Born that would have effectively moved many derivatives out of the shadows and made them subject to regulation."

Greenspan, Summers and Rubin all acted -- or failed to act -- to enable Wall Street's quest for higher profits via the opaque OTC market structure model and did so at the expense of the public interest. Instead of a truly free and transparent securitization market where occasionally a player does fail, today's OTC jungle ensures the destruction of a significant portion of capital deployed by dealers and investors both. How does this serve the interest of investors or the marketplace?"

[Larry]

The rush to the edge (of the risk cliff) is driven by the demand for higher returns. As less risky strategies become popular, their returns decline, so to maintain/achieve a higher return, you have to increase risk. This used to be self-limiting, until hedging and securitization obsoleted our definitions of riskiness.

I also find Blissex' notion of treating some of these strategies like insurance very powerful.

[Blissex]

«If 2006 is a quiet year for hurricanes, Greg Hagood stands to make a ton of money.»

On a hunch, I just done a little web search and it turns out that a "Greg Hagood" used to be at Bear Stearns:

http://www.alphamagazine.com/article.aspx?articleID=1358087
«Nephila, which relocated to Hamilton, Bermuda, in 1999, manages hedge funds that invest exclusively in catastrophe and weather-related reinsurance.
Before helping to start the firm, Hagood had managed the mortgage servicing trading desk at Bear, Stearns & Co. in New York.» (ten years ago though...)

If this is isn't perfect serendipity :-).

[skeptonomist]

As I predicted here a little while ago, any favorable trend in the economy will be taken as "proof" that the Fed's actions are both beneficial and critical. Bernanke is now the official new Maestro, according to Krugman.

There is a simple alternate hypothesis here, which is that the financial problems of Wall Street are not as bad as they have been made out, and/or not as critical to the real economy. Intervention of the kind actually done by the Fed was highly desirable to Wall Street and banks, and their voices were obviously much louder and better funded than the voice of Main Street.

Krugman is sensible on most subjects, but not on monetary policy and the role of the Fed. He has accepted the Friedmanistic dogma that money supply is the kingpin of the economy, and no events can shake this faith.

[Blissex]

«Shouldn't we just assume that regulations will be subject to "end runs" any time it seems possible to those with a vested interest in such things?»

Sure indeed. As old Benjamin said "the price of freedom is eternal vigilance".

But hey, the big vested interests are not stupid, and know how to game the system: by turning most voters into property speculators and rentiers, the big vested interests have managed to game the vigilance itself, by coopting and making small vested interests of voters themselves, who are now getting what they voted for.

How consciously designed was the end run around regulation thanks to vesting interests in the majority of voters? Let's hear someone who knows, Grover Norquist:

http://www.prospect.org/web/page.ww?section=root&name=ViewWeb&articleId=11699
«The 1930s rhetoric was bash business -- only a handful of
bankers thought that meant them. Now if you say we're going to
smash the big corporations, 60-plus percent of voters say "That's
my retirement you're messing with. I don't appreciate that". And
the Democrats have spent 50 years explaining that Republicans
will pollute the earth and kill baby seals to get market caps
higher. And in 2002, voters said, "We're sorry about the seals
and everything but we really got to get the stock market up."»

[Blissex]

Just closing some HTML tags.

[Blissex]

«I also find Blissex' notion of treating some of these strategies like insurance very powerful.»

Well, treating derivatives and securitisation as insurance is not my idea -- it was discussed even in a tutorial in the Economist.

My more modest contribution is to point out that if financial intermediaries are in effect selling insurance (while many insurance companies have ended up selling loans, see healthcare), then the classic panoply of insurance scams becomes possible to them...

[Lafayette]

Freedom of cupidity

blissex: ... then the classic panoply of insurance scams becomes possible to them...

Then you must admit that requiring capital requirements to all risk instruments should be a regulation. Meaning, "regulating the market".

Also, if banksters (good concoction, that) are doing it for the money, then subtracting that privilege (by means of confiscatory taxation above a certain annual amount) should lessen the temptation, shouldn't it?

It's one thing to complain, yet quite another to come up with a workable solution. Or, like last time, the mess will simply repeat itself. These people are thick -- they will NEVER learn.

Savings & Loan, Dot.com boom 'n bust, Sub-prime meltdown (and worst crisis since 1929)... where does the greed end? Uncontrolled capitalism gone wild? The bankruptcy of the nation?

This isn't incentivized free enterprise anymore ... it's freedom of cupidity.

[Lafayette]

Bloomberg: `Moral-Hazard Problem'

Richmond Fed chief Jeffrey Lacker and policy adviser Marvin Goodfriend wrote in a 1999 paper that central bank lending creates ever-expanding expectations. ``The rate of incidence of financial distress that calls for central bank lending should tend to increase over time,'' they wrote. That ``creates a potentially severe moral-hazard problem.''

Whatever regulations and incentives the Fed tries to put in place now would be evaded by the market's innovation of new types of products, Goodfriend said in an interview. Investors would nonetheless still count on the safety net, he added.

``We have to start now to recognize the strategic instability of the path we are on,'' said Goodfriend, now a professor at Carnegie Mellon University's Tepper School of Business in Pittsburgh. The Fed needs to prepare markets for how it won't intervene, which it didn't do before the Bear Stearns meltdown, he said.

[Blissex]

«[ ... ] Grover Norquist:
http://www.prospect.org/web/page.ww?section=root&name=ViewWeb&articleId=11699
«[ ... ] And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher. And in 2002, voters said, "We're sorry about the seals and everything but we really got to get the stock market up."»

As to this, opportunity to fix the link to the 30-year graph of the Countrywide stock price, here it is again with the right stock symbol:

http://money.CNN.com/quote/chart/charts.popup.html?symb=CFC&time=30yr

You can see what happened just after 2002, as Fed*mart renewed even more enthusiastically their "always rising asset prices - always" policy.

«This isn't incentivized free enterprise anymore ... it's freedom of cupidity.»

It is the Republican donor class getting the just rewards they have paid for. WINNERS!

[Cyrille]

"These people are thick -- they will NEVER learn. "

Oh, you are unfair to them. They quickly learnt that they would be bailed out no matter what. Or that some contributions would buy them political decisions anytime.

[RW]

"...it's freedom of cupidity."

Yes but when you have an increasing number of citizens, including those calling themselves 'libertarian,' who accept the religion of marketplace and its definition of this as the only real freedom there is then the stage for the corporatist state is truly set.

Enslavement through force is risky but if you can convince your victims to put the chains on themselves, even experiencing pride in the act, ah now ...that's genius.

[bullbust]

>Yes but when you have an increasing number of citizens, including those calling themselves 'libertarian,' who accept the religion of marketplace and its definition of this as the only real freedom there is then the stage for the corporatist state is truly set.

Don't forget the Fed, the economics profession which have become a toady of the the plutocracy. Nowhere is the religion more fervently practiced than in the economist priesthood itself. Heresy is crushed. They would rather destroy everything to prove their religion is the true one.

[ddt]

"I dont wanna say atodaso Julian but atodaso, I ****ing todaso." - Ricky from Trailer Park Boys

"ddt says...

For those here who would like to see a "New New Deal". How do you expect to forge a new deal, when you are giving away all your bargaining chips to the counter party? How do you expect to punish financial types during the good times when they will have all the leverage and you will have none? You can't. This is a unique opportunity for rebalancing that only comes around once or twice in a century, and so far it is being squandered through cowardice.

Posted by: ddt | Link to comment | March 16, 2008 at 04:11 AM"

[Blissex]

«when you are giving away all your bargaining chips to the counter party?»

But why worry when the Fed is providing absolutely free unlimited counterparty insurance? :-)

[paine]

"Getting the small stuff right matters"

really
or is it that narrow spectrum
that runs the gamit (sp)
between a grammar school teaching nun
and mr magoo realism

[paine]

i think paul k
here is "feeling"
this is not"the big one "
and ...well
if he's honest with himself
he's prolly disappointed
but then again hope is eternal
"..there’s every reason to believe that the next crisis ..."

like an early 50's brooklyn dodger fan
he cries at the wall street yankees

"wait until next year "

[save_the_rustbelt]

If we do increase regulation, we should look at Sarbanes-Oxley as an example of being too hasty.

This could have been done better with more time and more thought. It works, but could be better.

[im1dc]

Several comments on Our Professor Krugman's Editorial today:

He says truthfully "It’s still far from certain whether all this improvisation has resolved the crisis."

But then follows that up with this bit of untruth "But it was the right thing to do, and for the moment things seem to be calming down."

He would not let any student of his get away with that assertion so why should we let PK get away with it without asking for his supporting evidence to back it up.

Krugman provides no evidence b/c there is none. The crisis continues and will for the foreseeable future b/c the subprime mess continues through its ARM resets of 2010.

In truth the heart of today's Editorial regards the failure of partisan politicians inside the Beltway to learn from the recent past, specifically the LTCM crisis of 1999: "Through luck and skill, that crisis was contained — but rather than serving as a warning, the episode nurtured the false belief that the Fed had all the tools it needed to deal with financial shocks. So nothing was done to remedy the vulnerabilities the L.T.C.M. crisis revealed — the same vulnerabilities that are at the heart of today’s much bigger crisis."

He got that part right.

But then PK fails us again by confounding a truism, i.e., the next crisis will be bigger still, and a scare tactic prediction: "And if we don’t fix the system now, there’s every reason to believe that the next crisis will be bigger still — and that the Fed won’t have enough duct tape to hold things together."

The fact of the matter is that Bernanke's FED interfered with the free market of risk assumption in the same way that Greenspan's Fed interfered with the free market of risk assumption by bailing out Wall Street.

The net result must be to DELAY the inevitable, not cure or clear the problem, exactly as PK states in his criticism of the political failure to learn from the LTCM crisis.

Please allow the market for risk to work by allowing failures to fail.

If not our collective goose is cooked, it just hasn't been taken out of the oven yet.

[paine]

"Krugman gets the analysis completely wrong, because he seems
to think that the current problems are new"

blissex
you are wrong ..completely ?? who can tell

first this may indeed be but an avatar
of a built in
ageless credit market scam capacity

obviously paul's point
reg means
must evolve
even as hi fi instruments evolve
not ...with a lag

besides
his analysis of what went wrong this time
needs little past knowlege
hell my sig other got it right
and for said party
yesterday is history
last week archeology

[don]

Part of the problem is the asymmetric structure of executive pay that encourages exessive risk taking - heads they win, tails we lose. Executives should be rewarded for success, but also punished for failure. Now, CEO's stand to make many millions from share options when the company does well (or rather, appears to do well), but stand to lose very little if it fails. The current structure has also resulted in an overall level of executive pay is ridiculous.

[paine]

blis
your very intense
pounding
seems to be based on one notion

insurance is not banking

you belong in a simpler world

but your point about market failure
in risk markets is very very well taken
if not missed by paul k

in fact the insurance pardigm
almost ate micro in the 70's
when paul (and me )
got his brain soaked by econ con
greek letter flap doddle

[paine]

btw
blis
now you quote yourself

have you moved
that far ahead
of the rest of us
that now
you have to race around
and play
both sides of the net
to feel challenged ??

[paine]

swells
i like you leverage laws meme

[paine]

"Please allow the market for risk to work by allowing failures to fail.

If not our collective goose is cooked "

austrian ovens ???

why the fatalism
why the inevitable
bigger and bigger with every postponement
not always
true of a flood season levy

but the hundred year flood cometh
and adds vigor to pure structural conjecture
and
voila
a roasted myth

[Gerard MacDonell]

Ok, so we are not going to have a Depression. Rather, the regulatory backdrop is marginally suboptimal and needs to be tweaked. Gee, so THAT is why default spreads are cut in half. I go to Krugman for the cutting edge thoughts.

[Lafayette]

But ...

RW: Enslavement through force is risky but if you can convince your victims to put the chains on themselves, even experiencing pride in the act, ah now ...that's genius.

Well, despite my rants, I maintain a fundamental belief in the common sense of the American people. I know, I know, reelecting lead-head TWICE was really, really, stupid.

Still, if I don't have that basic faith then it would be better to cash in my chips. That's end-game. No, not for me.

It's true, we enslave ourselves through our own stupidity. But, history is replete with stories about how people awaken to truths and act accordingly.

So, keep the faith. (There's not much alternative anyway.)

NB: You can fool some of the people, some of the time. You can even fool most of the people, most of the time. But ...

[paine]

"So, keep the faith.
(There's not much alternative anyway.)"

laff
as is so often the case

u are the bob hope
prize line maker here

[Blissex]

«"Krugman gets the analysis completely wrong, because he seems
to think that the current problems are new"

blissex
you are wrong ..completely ?? who can tell
first this may indeed be but an avatar
of a built in
ageless credit market scam capacity
obviously paul's point
reg means
must evolve»

«insurance is not banking
you belong in a simpler world
but your point about market failure
in risk markets is very very well taken
if not missed by paul k»

My point is that new regulation is not needed; just old regulation.

Because the problem is not caused by banks selling new fangled instruments, but selling very old instruments, but sold by insurance companies.

The most obvious symptom is that the rating agencies have become actuaries too, and the regulatory failure is not that being an actuary is a new and so far unexamined trick.

More detail: when a rating agency rates a bond, they are rating a company's business risk; it is a call of judgement on good the bond issuer business cash flow is going to be at covering the repayment of the loan.

But then a rating agency rates a synthetic security like a CDO, they are not rating a company and a business risk: they are rating a population and a statistical risk.

So they are not rating a security, they are rating a policy.

Regulators have dozens and hundreds of years on how to regulate insurance products, and on how to detect and handle insurance fraud.

We don't need more or new regulation -- just to apply existing regulations by product, not by type of company selling them. I am just hoping for insurance regulators, which are often state regulators, often in blue states, to start investigating investment banks, rating agencies and audit partnerships as having operated in the insurance business without a suitable insurance charter.

BTW, quite entertainingly and I reckon entirely not coincidentally, the Republican administration has tried to remove a lot of insurance supervision from the states recently, to safely neuter it at the federal level.

[RW]

Hmmm, I think I just heard you Blissex: If you were going to write a letter to your state's insurance regulator making that case, how exactly would you phrase it, what would you stress?

[paine]

to reinforce
the bliss point
lest anyone thinks he's wrong about regs as he is about krugman

we don't need new regs
insurance or banking
default risk is well documented

we don't need innocation
as much as
new expanded zones of reg authority
and more regulators to wield that authority
and not a gentle ben reactive bricolage
but a premptive proactive
punch bowl removal

[Spectator]

I'm glad to see Krugman establish a link between LTCM and the current crisis. He senses that moral hazard planted the seeds for this bigger crisis. Yet, he can't seem to connect the dots.

The irony here is the liberal economists defense of "socialist" bailouts for the rich. Many of us can see the travesty here, but Krugman is blinded or chooses not to see, saying it was the right thing to do.

Any liberal should be outraged by Fed handouts to Wall Street. I gather his thirst for bigger government control of the economy outweighs his moral outrage. Moreover, this kind of Fed meddling is often featured in his own economic prescriptions, so it may just be CYA behavior at work.

[Spectator]

Here's another exercise in connecting dots for Krugman. Bank of America is about to walk away from Countrywide unless it gets the same kind of deal as JP Morgan. This time it's even a bank that's in trouble. BofA would be foolish not to demand the same Fed backstop. And can the Fed resist?

Welcome to moral hazard on steroids.

[Farrar]

Blissex wrote
"A $500,000 mortgage is only terrible if it is on a $250,000 home, but it is a very profitable asset if it is on a $600,000 home."

Not necessarily. Foreclosure may cost 50%

As Tanta reminds us, there are 3 C's to good credit - not just one C -

Not just Collateral, but also Character and Capacity.

If all three C's are not applied consistently over time, there is no sound basis for actuarial analysis of mortgage backed securities, and therefore no rational basis for determining a prudent amount of reserves.

Thats why banking is not like insurance as Paine so rightly pointed out

And that's why regulation is most needed at the originator's level..

[anne]

http://www.nytimes.com/2008/05/06/opinion/lweb06foreclosure.html

Ending Housing Disparities

To the Editor:

“The Pain Spreads: Foreclosures, Even in Greenwich”: *

The demise of homeownership at the grip of foreclosures is rippling across the country, even in affluent communities, as your article conveys.

According to the Center for Responsible Lending, over the next several years roughly 20,000 American families will lose homes each week. “Victims among the affluent,” while important, are not the population hardest hit in this morass. As the article illustrates, foreclosure does not threaten only the irresponsible or those with bad credit.

At alarming rates, minority homeowners, many with good credit, have fallen prey to foreclosures by being steered to disadvantageous subprime loans that are souring at astonishing rates. A vastly disproportionate number of Hispanics and blacks who took out purchase mortgages received higher-cost loans compared with whites and Asians.

Financial institutions and Congress alike must put an end to housing disparities and work to ensure affordable housing — free from predatory lenders for all Americans.

Barbara R. Arnwine
Washington, April 27, 2008
The writer is the executive director of the Lawyers’ Committee for Civil Rights Under Law.

* http://www.nytimes.com/2008/04/25/business/25foreclose.html

[anne]

"At alarming rates, minority homeowners, many with good credit, have fallen prey to foreclosures by being steered to disadvantageous subprime loans that are souring at astonishing rates. A vastly disproportionate number of Hispanics and blacks who took out purchase mortgages received higher-cost loans compared with whites and Asians."

We are just not paying attention.

[hari]

If Fed cannot get some (official) support to slow down foreclosures and also protect legitimate home owners in the process, the current meltdown may cascade until market finds a bottom. There's no other alternative at present on the table.

[Lafayette]

The Blameless Society

anne, article: free from predatory lenders for all Americans.

That's easy. Take TILA, the Truth In Lending Act; RESPA, the Real Estate Settlement Procedures Act; and HOEPA, the Home Ownership and Equity Protection Act -- and apply them to cases of predatory lending. (Further explanations, here.)

The contraventions are penal offenses. But, as the cite article notes, they are conceived badly to address explicit predatory lending.

They therefore (particularly HOEPA) require reworking. HOEPA needs to be reset to trigger at lower interest rates.

Haven't we had enough of the Blameless Society where harm is done but the culprits are unpunished?