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Michael's bleg beg
He sounds like a very loyal MR reader to me:
Would you be willing to post a financial crisis topic bleg thread, where people can submit questions in comments and you occasionally pick from those questions?
I have so many questions as I try to get a handle on this stuff. I bet others do too, and that many questions are the same.
I make no promises but ask away...
And I haven't forgotten your earlier requests, I hope to return to many of them once we are out of the woods.
Posted by Tyler Cowen on September 29, 2008 at 01:51 PM in Current Affairs | Permalink
Comments
Thank you very much for answering my request! That's the kind of responsiveness that keeps us all coming back to MR ;)
I'll submit a few possibilities:
People cite "leverage" as one culprit in the financial crisis. Why was leverage being over-used, if indeed it was?
In the long term, will we have to convert all OTC derivatives into exchange-traded so we can keep better track of the market's overall risk profile?
More generally, what are the options for ensuring the more accurate risk profiling of a derivative? Are these good options? Better than simply forbidding CDS's for example?
What was the "first cause" which led private lenders to lose their minds and make risky loans? Once there is a bubble going, "greed" is perhaps a pretty good explanation for how it continues, but how did it start? Was there a new generation of lenders who didn't understand the principles of mortgage lending?
There seems to be a bad incentive structure where people in finance can make short term profits and ultimately crash Wall Street and even if they lose their jobs they still have their last 10 years of big paychecks. Regulation aside, can we introduce market instruments/mechanisms that allow people to profit off of the short-term/long-term tradeoff, to put things back in balance?
Posted by: mk at Sep 29, 2008 2:13:58 PM
One of my previous employers was criticized for being run purely by the managers for the managers, without consideration for the shareholders. I get the impression that the same criticism can be directed at the financial sector.
As I see it, there is a surplus of people wanting to get into the financial industry, with the "brand names" being most favored. Basically, more people want to get in than are hired.
Despite this, the majority of the industry surplus seems, to me, to over time accrue to employees, not to customers or equity holders.
Maybe I'm missing something obvious here, but shouldn't equity holders in the financial industry take a much stronger interest in employee compensation than what they seem to do?
Posted by: johan at Sep 29, 2008 2:27:51 PM
First of all, thanks again for the best econ blog out there.
Second, I am most interested in the last issue raised by MK above: the incentives of the various participants in the creation of this mess. It is something of an unfair question since this is my own area of research, and I should be able to answer it as well as you, but, gosh, I am baffled.
I understand the incentives of a hedge fund manager on a 2/20 compensation scheme to take lots of tail risk and to hope for the best. The same applies to the unit of AIG that wrote all of these CDSs. But what about AIG's board? What about Hank Greenberg? Didn't he have every incentive to prevent this from happening? Or what about James Cayne at Bear Stearns? He had tons of equity in the firm and should have been very keen on wealth preservation. Why didn't he create adequate risk management systems?
Posted by: Commenterlein at Sep 29, 2008 2:28:03 PM
Is the problem a lack of regulation or are regulators like Elmer Fudd chasing faster, smarter, constantly morphing rabbits, they do more damage to innocent trees with their weapons then anything else?
If my neighbor owns a fire trap and one day his houses catches fire, do I have a choice other then helping to fight the fire before it destroys the neighborhood?
Was Reagan wrong and Obama correct? Is the path to prosperity more government regulation, more government control, and taxes based on equity issues?
Is the challenge we are facing going to change the face of capitalism? Was this vote a vote on the future of capitalism?
Posted by: DanC at Sep 29, 2008 2:29:25 PM
Taking off my economist hat and putting on my self-interested voter hat, my one and only question is, why should I care what happens to these idiot banks?
I don't have a need to borrow several million dollars so the alleged credit shortage doesn't scare me. The company I work for is profitable and as far as I know doesn't finance anything with debt, and neither does our customer base (unless you count credit cards). I still get a dozen credit card apps in the mail each week, and banks -- even Wachovia -- are still on TV telling me how I should get a loan from them. Basically, aside from a few companies with famous names facing bankruptcy, I don't see what the problem is. So why should I be eager to go on the hook for a share of $700+ billion? Why can't we just let them fail?
If GM or United Airlines went bankrupt, their investors would take a bath, someone would buy their assets on the cheap, and life would go on. Are financial services bankruptcies different? If so, isn't THAT the problem we should be solving?
Posted by: Noah Yetter at Sep 29, 2008 2:30:06 PM
Is the change to mark-to-market accounting rules a big deal? Is it just killing bad firms too fast for everyone to deal with, or is it also making it difficult for otherwise good firms to wait out the market downturn with assets that are likely to recover in value.
Back when the change over was being discussed it made lots of sense because it would keep firms from claiming assets that weren't ever likely to recover (think Ford cars that didn't sell in the model year--they aren't ever going to hit anywhere near new car value), but is it also causing problems for assets that are probably ok in the long run?
Posted by: Sebastian at Sep 29, 2008 2:39:03 PM
Let me second Noah's question above: why can't we just let them fail?
Posted by: Robert at Sep 29, 2008 2:52:24 PM
I'm not old enough to remember the S&L crisis, so how does this compare in terms of national sentiment, Congress, etc.? Did people think it was going to be the end of capitalism? How does the damage thus far compare?
I hear people like Krugman say this is the nastiest thing he's seen in decades. I can see some structural similarities (deregulation, expanded lending, etc) from reading about the two, but obviously they didn't have things like MBS/CDS back then.
Posted by: pants at Sep 29, 2008 3:07:32 PM
mk
A pretty good guess of first cause was the capital gains tax break from 1997, that should have (and did) cause a one time increase in home prices. However, it's timing led to that increase occuring as stocks producing large negative returns (just as housing was continuing to show increasing returns, and with low interest rates that followed we were off to the races.
Posted by: nelsonal at Sep 29, 2008 3:14:00 PM
Why isn't the Fed lowering interest rates?
Wouldn't this add to liquidity and help avoid a recession/depression? Surely, we're not at risk of inflation right now.
Posted by: Jim Gannon at Sep 29, 2008 3:18:26 PM
I had a couple of questions/comments as well:
I was watching Barney Frank on Charlie Rose, and several times he talked about wanting that "no foreclosure" option built into the bill, so that certain homeowners (based on some criteria, I suppose) wouldn't lose their house. Is it possible that this could turn the "up" side of selling off these mortgage-backed assets into a downer? Or at least drastically affect the "it's not really going to cost $700 billion" argument?
This also brings to mind the notion that, like in Iraq, we need an exit strategy. I have heard cynical people assert that we went into the Middle East not really wanting to get out. I do wonder whether certain members of Congress want to build a nice outpost in the financial sector. Isn't that why Fannie and Freddie kept growing?
Posted by: DavidR at Sep 29, 2008 3:23:55 PM
How much credence should be given to Steve Sailer's narative? It's provocative and interesting, but is there any truth to it?
Posted by: josh at Sep 29, 2008 3:29:54 PM
Very basic question of fact: What has been the recent default rate among mortgaagees and how does it look in comparative historical terms? and how big have been the banks' set-asides for defaults over the past three years and how do these set aside magnitudes look in comparative historical terms? In this regard, it'd be informative to separate the "sub-prime" from the "prime" mortgage data, insofar as that's possible; and also good to get down into the default rate or "degree of impairment" that is occurring for particular types of mortgage "strip" products, provided we are also being shown the magnitude of these strips in relation to the whole scene. In other words, I don't know the magnitude of the non-performing mortgages problem.
If any reader can point me to a site that is already presenting this information I'd be grateful for the link.
Posted by: phineas at Sep 29, 2008 3:39:57 PM
People are scared. Should they be? Should the average person be scared of what is going on? No one seems to give any straight answers. I think this blog, Tyler and Alex, are the best shot we have to understand what is going on and what is not going on.
Is this the end of the economy? Greater than the last great depression? That's what we've been hearing over and over. What's the truth, or at least as far as you can see it? Can you tell us what is happening in everyday language, and what are the scenarios of what will happen?
I'm not kidding when people think this is going to be an Armageddon. People are getting freaked out.
Posted by: Daniel at Sep 29, 2008 3:42:04 PM
mk, I think he was being sarcastic when he said you must be a loyal reader. Tyler has done a lot of threads like these.
Posted by: j10s at Sep 29, 2008 4:08:51 PM
1) What fraction of the pundrity is lying on this issue to protect their narrow self interest, while
attempting to rationalize it as being for the common good? How does this compare to regular pundit opinions?
(I *know* Megan_McArdle is doing this on the issue.)
2) How the the harm of "no bailout" compare the harm of "signaling to the financial industry that they can
continue to hold the rest of the economy hostage and always thereby win concessions"?
Posted by: Person at Sep 29, 2008 4:09:14 PM
In the S&L crisis, we didn't have the internet which allows individuals to weigh in. To the extent that the current bailout proposal is the top news story, it seems to me that the media coverage, combined with the election coverage, gets millions more people involved. Two other factors are the financial media (cable TV) and the proliferation of individual brokerage accounts and investment.
I'd be interested to know what the effects are of media/internet today on Congress compared to the process of developing the FIRREA legislation in 1989 that created the RTC. It seems that now there are many more individuals, stoked by the media, who, in an election year, have an opinion strongly against the current bailout plan. I don't think that there is wisdom in this crowd, given that the underlying issues are poorly understood and now there is an angry mob forming.
It's a media/political question, not a purely economic one, but my hypothesis is that the changed nature of the individual's role is feeding volatility.
Posted by: Laocoon at Sep 29, 2008 4:10:21 PM
What should we be monitoring? Everyone is watching the stock market because it is easy and familiar. However, the bailout is being sold as a way to keep credit markets functioning. How do we know if credit markets are not functioning?
Why is keeping credit markets functioning tied to federal purchase of certain bad assets? Isn't there a way to seperate the smooth provision of credit from these bad assets?
Where are the investing opportunities right now? If I am someone in a position to provide liquidity to markets, how would I do that? What price mechanisms are encouraging me to do that?
Posted by: donoby at Sep 29, 2008 4:16:52 PM
Arnold Kling has glancingly floated the idea of Treasury simply investing gobs o' money into bond funds.
An utterly superficial thought sez: seems sensible. But...
Does this make sense? Would it do the trick? What are the gotchas?
Posted by: Steve Roth at Sep 29, 2008 4:20:14 PM
Definitions! There are a zillion specific-sounding terms which I'm not sure whether they actually have a specific meaning or not. "Capital injection," for example. Does that just mean "gift"?
Posted by: Jeff Brown at Sep 29, 2008 4:20:46 PM
I have heard or read a number of people place partial blame for this situation on CEO pay packages. I think that to the extent that a CEO is incentivised to think of the short term over the long term, risky loans/actions were probably encouraged.
With that in mind, would increasing the time horizon of stock options for corporate leaders be a good idea? Imagine the majority of CEO's upside were to come from how the stock is doing in 10, 20 and/or 30 years. Are there any public companies that operate this way?
Posted by: nosneb at Sep 29, 2008 4:24:06 PM
j10s: While you are right that there have been other blegs on the site, I am truly hopeful that this can be the bleggiest of them all.
Posted by: mk at Sep 29, 2008 4:46:49 PM
What would Milton do?
Posted by: CD at Sep 29, 2008 4:49:53 PM
Question.
Might the very low interest rates in the US be hindering not helping the recovery?
Low interest rates mean:-
Its not worth the banks lending to each other without high premium given that inflation is 5% plus.
It keeps alive the zombies in the banking sector thus slowing the work out.
It disincentivises saving - and the main problem in the fnancial sector is surely a lack of deposits?
I appreciate that this is a bit against the grain but is it stupid too?
Posted by: Giles at Sep 29, 2008 4:55:43 PM
I was thinking the same thing as Noah. I actually work on Wall Street and see things first hand. Even the people I know at Bear and Lehman have quickly landed on their feet somewhere else.
I can understand the concern about the impact a crisis of confidence in the financial system can have on the broader economy. But I worry more about the fact that we are trying to maintain the current level of consumption despite the fact that it has been driven by unsustainably increasing debt ratios in both government and households - which Fed action is only going to exacerbate. That risk is being rerated and spreads are widening, to me, seems appropriate given that they had been abnormally low in the last few years.
The bottom line is can households and businesses who properly manage their finances get access to debt they need? I see no indication that it is a problem.
Posted by: asiequana at Sep 29, 2008 5:00:06 PM
