Transcript BUBBLE TROUBLE

BUBBLE TROUBLE
Myths and Realities of the Failure of
CRapitalism that Caused the Great Recession
Gene Epstein
[email protected]
Junto, July 7 2012
Dan O’Connor
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BUBBLE TROUBLE
Myths and Realities of the Failure of
CRapitalism that Caused the Great Recession
Gene Epstein
[email protected]
Junto, July 7 2012
“Great Recession of 2008-09”
• --The longest and deepest contraction of the U.S. economy
since the Great Depression of the 1930s.
• --Rate of unemployment nearly doubled to more than 10%.
“Capitalism”
• A private enterprise system of profit and loss.
• --Profits encourage risk-taking.
• --Losses encourage prudence.
CRAPITALISM
• Contraction of “crony capitalism.”
• An economic system in which losses are
absorbed by the government.
• Thus, without losses encouraging prudence,
profits encourage far more risk-taking than is
normal in a capitalist system.
Crapitalism
• Two key examples (key players in our drama):
• --Federal National Mortgage Association
(“Fannie Mae”)
• --Federal Home Loan Mortgage Corporation
(“Freddie Mac”)
• “Government-sponsored enterprises”-GSE’s
Real Home Price Index (1890-2011)
200
175
150
125
100
75
50
1890
1911
1932
1953
1958
1963
Note: Home prices deflated by Consumer Price Index;
1890-1952 year end, 1953-2011 quarterly.
1968
1974
1979
1984
1989
1995
2000
2005
2010
Source: Shiller’s Irrational Exuberance
House Prices & Homeownership Rate
225
69.5
200
68.5
67.5
175
66.5
150
65.5
64.5
125
63.5
100
1965 - 1967 - 1969 - 1971 - 1973 - 1975 - 1977 - 1979 - 1981 - 1983 - 1985 - 1987 - 1989 - 1991 - 1993 - 1995 - 1997 - 1999 - 2001 - 2003 - 2005 - 2007 - 2009 - 2011 Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Shiller Historical Housing
US Homeownership Rate 4-quarter moving average
Note: Data from Q1 1965- Q4 2011; Shiller Historical Housing – Left Scale;
Homeownership Rate – Right Scale
Source: Shiller’s Irrational Exuberance,
Haver Analytics
62.5
Krugman on the Fed
…[M]acroeconomists were divided in their views. But the
main division was between those who insisted that freemarket economies never go astray and those who believed
that economies may stray now and then but that any major
deviations from the path of prosperity could and would be
corrected by the all-powerful Fed. Neither side was
prepared to cope with an economy that went off the rails
despite the Fed’s best efforts [italics added]
--”How Did Economists Get It So Wrong?”
New York Times Magazine, Sept 6, 2007
“To fight this recession the Fed
needs more than a snapback; it
needs soaring household spending
to offset moribund business
investment. And to do that, as Paul
McCulley of Pimco put it, Alan
Greenspan needs to create a
housing bubble to replace the
Nasdaq bubble.” –Paul Krugman,
Aug. 2, 2002
“In July 2001, Paul McCulley, an economist at
Pimco, the giant bond fund, predicted that the
Federal Reserve would simply replace one
bubble with another. ‘There is room,’ he wrote,
‘for the Fed to create a bubble in housing
prices, if necessary, to sustain American
hedonism. And I think the Fed has the will to
do so, even though political correctness would
demand that Mr. Greenspan deny any such
thing.’“—Paul Krugman, May 27, 2005
“As Mr. McCulley predicted, interest rate cuts
led to soaring home prices, which led in turn
not just to a construction boom but to high
consumer spending, because homeowners
used mortgage refinancing to go deeper into
debt. All of this created jobs to make up for
those lost when the stock bubble burst.” -- Paul
Krugman, May 27, 2005
“But although the housing boom has lasted
longer than anyone could have imagined, the
economy would still be in big trouble if it came
to an end. That is, if the hectic pace of home
construction were to cool, and consumers
were to stop borrowing against their houses,
the economy would slow down sharply. If
housing prices actually started falling, we'd be
looking at a very nasty scene, in which both
construction and consumer spending would
plunge, pushing the economy right back into
recession.” -- Paul Krugman, May 27, 2005
Krugman Recants
“The reality of the financial crisis was that
deregulation — which was part of a broader
rightward shift in policies that played a large
role in creating rapid growth in income
inequality — led to an economic catastrophe
of the kind that just didn’t happen during the
50 years or so when we had effective bank
regulation.----Krugman, “Financial Big Lies,”
Nov. 7 2011
Deregulation
•
1.
2.
3.
…meant three main things since mid-1980s
Elimination of Regulation Q
Elimination of restrictions on branch banking
Partial elimination of Glass-Steagall
restriction on commercial banks affiliating
with investment banks
●Partial repeal of Glass-Steagall to blame?
”Glass-Steagall legislation, which kept Wall Street
and Main Street banks walled off from each other,
was repealed in 1998. This allowed FDIC-insured
banks, whose deposits were guaranteed by the
government, to engage in highly risky business. It
also allowed the banks to bulk up, becoming
bigger, more complex and unwieldy.”—Barry
Ritholtz, “What Cause the Financial Crisis?”
Washington Post, Nov. 5 2011
Partial repeal of Glass-Steagall
to blame?
“Gramm-Leach-Bliley isn’t
entirely blameless. For one
thing, the mergers it
encouraged left banks with
more capital to invest; some
of the capital ended up in that
deluded subprime mortgage
market.”—N.Y. Times, David
Leonhardt, Sept. 26, 2008
Three Main Factors
1. Enabling factor: central bank’s negative interest-rate
policy, 2002-05
2. Propelling factor: U.S. government’s housing policy
beginning in 1992
3. Precipitating factor: replacement of mortgage
bankers with casino capitalists
1. Enabling Factor
central bank’s negative interest-rate policy,
2002-05
2. Propelling factor
U.S. government’s housing policy beginning in
1992
Oct. 1992 Title XIII Housing and Community
Development Act
• “The purpose of the [affordable housing]
goals is to facilitate the development in both
Fannie Mae and Freddie Mac of an ongoing
business effort that will be fully integrated in
their products, cultures, and day-to-day
operations to service the mortgage financing
needs of low-and-moderate-income persons,
racial minorities, and inner-city residents.”—
from Senate Committee report on the
legislation.
Krugman on inequality
• “[T]he right’s answer is to claim not just that
the government did it, but that it caused the
crisis by its attempts to reduce inequality! It’s
kind of a masterstroke, in an evil way.”
• --Krugman, “Financial Big Lies,” Nov. 7 2011
Bill Clinton, 1994
• In 1994 President Bill Clinton directed HUD to
boost the homeownership rate to an “all time
high by the end of the century,” and HUD
secretary Henry Cisneros set a goal of a 70
percent homeownership rate in the Nation-al
Homeownership Strategy of 1995.--”What
Made the Financial Crisis Systemic?”
Hendershott and Villani, March 6, 2012
President Bush, 2002
• “The goal is, everybody who wants to own a
home has got a shot at doing so. The problem is
we have what we call a homeownership gap in
America… And we need to do something about
it… We are here in Washington, D.C. to address
problems. So I've set this goal for the country. We
want 5.5 million more homeowners by 2010…
economic security at home is just an important
part of -- as homeland security. And owning a
home is part of that economic security. It's also a
part of making sure that this country fulfills its
great hope and vision.”
President Bush, 2002, cont.
• “And I'm proud to report that Fannie Mae has
heard the call and, as I understand, it's about
$440 billion over a period of time. They've
used their influence to create that much
capital available for the type of home buyer
we're talking about here. It's in their charter;
it now needs to be implemented. Freddie Mac
is interested in helping. I appreciate both of
those agencies providing the underpinnings of
good capital.”
House Prices & Homeownership Rate
225
69.5
200
68.5
67.5
175
66.5
150
65.5
64.5
125
63.5
100
1965 - 1967 - 1969 - 1971 - 1973 - 1975 - 1977 - 1979 - 1981 - 1983 - 1985 - 1987 - 1989 - 1991 - 1993 - 1995 - 1997 - 1999 - 2001 - 2003 - 2005 - 2007 - 2009 - 2011 Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Shiller Historical Housing
US Homeownership Rate 4-quarter moving average
Note: Data from Q1 1965- Q4 2011; Shiller Historical Housing – Left Scale;
Homeownership Rate – Right Scale
Source: Shiller’s Irrational Exuberance,
Haver Analytics
62.5
Dollar Value of all First Mortgage Originations
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
1990
1991
1992
Source: Inside Mortgage Finance
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
$ Share of First Mortgages with Less than 3% Downpayment:
Fannie, Freddie, FHA
30%
25%
20%
15%
10%
5%
0%
1993
1994
1995
Sources: FHA, Fannie Mae, Freddie Mac
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Fannie and Freddie’s Share of Mortgages Targeted to Below-Median Income
Buyers
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
1993
1994
1995
1996
1997
1998
1999
2000
Note: Incremental GSE Affordable Annual Housing Volume above 30% Historic
Baseline/Annual Total Origination Volume
2001
2002
2003
2004
2005
2006
2007
Private Sector Share of Subprime
7.50%
5.00%
2.50%
0.00%
1993
1994
1995
1996
1997
1998
1999
2000
-2.50%
-5.00%
Sources: Inside Mortgage Finance; Incremental Self-Denomination Subprime Annual
Volume Percentage (net of Fannie/Freddie PMBS subprime purchases) above 1992
Baseline of 9% of Annual Total Origination Volume
2001
2002
2003
2004
2005
2006
2007
Share of NTM’s: Fannie/Freddie vs. Private Sector
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
-2.00%
-4.00%
Incremental GSE Affordable Annual Housing Volume above 30% Historic Baseline/Annual Total Origination Volume
Incremental Self-Denomination Subprime Annual Volume Percentage (net of Fannie/Freddie PMBS subprime purchases) above 1992 Baseline of 9% of
Total Originations/Annual Total Origination Volume
2007
Krugman on no-risk Fannie & Freddie
• “[Fannie and Freddie] didn’t do any subprime lending,
because they can’t . . . by law.
•
“ . . . So whatever bad incentives the implicit
federal guarantee creates have been offset by the fact
that Fannie and Freddie were and are tightly regulated
with regard to the risks they can take. You could say
that the Fannie-Freddie experience shows that
regulation works.”—”Fannie, Freddie, and You,”
New York Times, July 14, 2008
800-Lb Gorilla
• Sept. 2008: Fannie and Freddie’s creditors are
bailed out by the federal government
• Dec. 2011: the SEC, chaired by the Obamaappointed Mary Schapiro, seeks
“disgorgement of ill-gotten gains” from six
former Fannie and Freddie executives, based
on the allegation that they “caused the federal
mortgage firms to materially misstate their
holdings of subprime mortgage loans.”
800-Lb Gorilla, cont.
• SEC estimate of $ value of high-risk mortgages
held by F&F as of June 30 2008: $1.7 trillion
• SEC estimate of F&F losses from Jan. 2007
through March 2011: $241.3 billion
• Ed Pinto estimate of F&F losses from Jan. 2008
through Dec. 2011: $242 billion
Federal vs. private share of high-risk
mortgages—June 30, 2008
No of loans Unpaid Princ.
• Federal
•
• Private
• TOTAL
• Source: Edward Pinto
20.6 million
$2.9 trillion
7.8 million
$1.9 trillion
28.4 million
$4.8 trillion
“The Fannie and Freddie Hate Storm”
--Holman W. Jenkins, Jr. Dec. 28 2011
• “Yes, we had a housing bubble. Yes, we had deterioration in lending
standards. Fannie and Freddie had a role in both….
• “But these things did not lead inexorably to the panic of 2008. The
housing losses should have been manageable by the financial
system. A systemic meltdown came instead because a handful of
giant financial institutions in the U.S. and Europe had leveraged up
with short-term and even overnight borrowings in order to hold
complex mortgage derivatives that suddenly became illiquid and
hard to value….
• “The role of Fannie and Freddie in all this? Very little, except that
their seizure accelerated the unraveling of equity values across the
banking system as investors feared nationalization would be the
fate of other large and flailing financial institutions.”
Similar fallacy
• “There is no evidence that the crisis—as
opposed to the housing bubble—was caused
by…Fannie and Freddie.”
• --Engineering the Financial Crisis, by Jeffrey
Friedman and Wladimir Kraus
Counter-factuals to Jeffrey Friedman
• 1. There could have been many subprime PLMBS,
but market panic over them would not have
affected banks so severely, if there had not been a
burst housing bubble.
•
2. There would not have been a housing bubble
that blew up and burst with such severity had
government agencies not accumulated such a
massive position in non-traditional mortgages.
Counter-factuals to Jeffrey Friedman
• 3. Had the federal government not gotten so
aggressively into non-traditional mortgages
starting in the 1990s, via the various agencies,
the later accumulation of NTM PMBS by banks
would not have occurred in such size or so far out
the risk-curve.
• As Wallison wrote in his review, "Bubbles tend to
suppress delinquencies and default, and by the
early 2000s, the losses on subprime and other
low quality mortgages were substantially lower
than past experience would have suggested."
Friedman’s shocking response
• “I agree with everything you say here…the
book was written for course adoption at elite
liberal-arts colleges. There has to be a certain
amount of conservative-bashing rhetoric in
order to get through that door, there to sow
radical new thoughts.”