Arnold Kling  

Afternoon Commentary

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An Ex Ante Aneurysm... Leaning Against the Wind...

Bloomberg interviews William Poole. Bloomberg doesn't permalink their video interviews, so I just linked to the page where I found it. It's not necessarily worth watching the whole thing. The essential message is that he doesn't like leverage. He even suggested phasing out the deductibility of interest on corporate income taxes as a way of encouraging less debt and more equity.

I think that would only lead to financial excess showing up in a different way. I think we're better off dealing with the system as it is than tampering with it.

On housing, I absolutely agree with Poole. If we go back to 20 percent down payments, the market will be more stable. I'm sure that in a free market we would see 20 percent down payments. Barney Frank is the only person I can think of who still wants to lend with little or no money down. He's welcome to do it, but I dare him to use his own money instead of ours.

One of the big newspapers asked me to do an op-ed on alternatives to the rating agencies. I think they were expecting me to say, "If you just use method X to rate mortgage securities instead of using Moody's and S&P, we'll be fine." Instead, what I wrote was that with low down payments, the housing market is unstable, and ultimately mortgage lending of any kind is unsustainable. I don't think the op-ed is going to run.

I honestly think that the commentators who blame the rating agencies have the least credibility of anyone. None of the big institutions that have made the headlines this year bought mortgage securities on the basis of ratings. In fact, AIG's business model was to insure the default risk on mortgage securities. That business was based on the fact that nobody took the ratings seriously, and instead they bought protection from AIG. If AIG measured the risk incorrectly, that reflects on their internal risk assessment, not on the rating agencies.

The other interesting news is market behavior. Effective COB yesterday, I took some money out of Treasury securities and put it into a stock index fund. Today, I got trampled by people running in the opposite direction. Megan and Tyler say that the three-month t-bill rate is down to one basis point.

It's like the government is the only hedge fund anyone will lend to any more. When inflation is at least two percent, and you can borrow at zero, you can make a profit holding just about anything. It's every corporate raider's wet dream. Given how generous the bond markets are, Bernanke and Paulson ought to just keep the acquisition spree going. The more they add to the balance sheet, the cheaper it gets for them to borrow. If they run out of firms in difficulty, then Ben and Hank should just go ahead and make hostile tenders for healthy companies, too. In this market, management has no takeover defense.

UPDATE: Ken Rogoff writes,


If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.

Something has to give.


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COMMENTS (6 to date)
Lance writes:

Couldn't we get companies to finance with more equity, as opposed to debt, by eliminating the dividends tax?

Jim writes:
I'm sure that in a free market we would see 20 percent down payments.

We would obviously see some but the right question is whether there would be a substantial proportion of lenders using much higher LTVs, and international comparisons suggest there would be. Before markets peaked, 100% mortgages became common in the UK, Spain and Ireland, which have completely different regulatory systems from the US and no obligations on lenders to serve low-income borrowers. Nobody was forcing these lenders to ask for zero money down, so trying to pin all the blame on government doesn't really cut it.

matt writes:

[Comment removed pending confirmation of email address and for rudeness. Email the webmaster@econlib.org to request restoring this comment. A valid email address is required to post comments on EconLog.--Econlib Ed.]

Chuck writes:

I don't understand why the ratings agencies are not more at the center of this story.

I think it was the AAA rating from the rating agencies that made a lot of the junk 'sell-able'.

When you talk about replacing transparency with trust, that's points at the rating agencies to a large degree.

Per Kurowski writes:

Is a young boy allowed by his father to roam around only in the company of a governess really free?

Of course not…and so please don’t tell me that what we have now, the banks having to put up capital in accordance to what the quite volatile risk kommissars opine, is a free financial market!

Of course a free market would never have bought into the shamefully bad mortgages awarded to the subprime sector.

Please, let the banks be banks again!

Please, let the banks be banks again!

Good advice, but it will take Congress reversing its 1990s legislation:

No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."

Some of these "outdated" criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt.

Sound crazy? You bet. Those "outdated" standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

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