Arnold Kling  

The Shadow Knows

Hurricane Lehman Update, 10 AM... Is FDA Paternalism a Public Go...

The Shadow Financial Regulatory Committee, that is. They meet quarterly, under the auspices of the American Enterprise Institute, and their latest meeting took place while the real financial regulators were deciding to let Lehman walk the plank. Today, shortly after noon, the Shadow supported that decision.

The Q&A was lively. The best question got the best answer. Cato's Bill Niskanen asked what was the difference between Bear Stearns, which got bailed, and Lehman, which didn't? Peter Wallison said that markets actually have more confidence now, so they are better able to withstand a bankruptcy. The Bear implosion took everyone by surprise. But the Lehman situation took place in slow motion. Financial institutions have had time to adjust their exposures and raise capital. In March, no one knew who was in trouble and who was sound. Now, there is a consensus about who's in trouble, and more trust in the folks who are not on everyone's problem list. Nobody can be sure, but this view suggests that it is possible to put a firewall around Lehman, whereas that was not possible back in March with Bear.

Somebody asked about the credit rating agencies. The Shadow thinks that markets did not rely on them, although regulators did to some extent. Charles Calomiris pointed out that the Basel capital regulations favor almost any securitized debt over safer instruments. He said that years ago everyone knew that BBB structured debt defaulted at a much higher rate than BBB corporate bonds, but regulation does not recognize such differences.

Ed Kane said that the credit rating agencies do a fine job with ordinary bonds. The problem is that with structured debt their rules get manipulated. Structured debt is more volatile, but the rating agencies don't report confidence intervals around their ratings.

The point is you should not try to fix the rating agencies. You should try to get regulators to use other measures of risk that are readily available in the market. Private investors can figure out when to use the ratings and when not to.

Calomiris says he does not think that the repo market in mortgage securities is coming back. I talked about the repo market in my previous post.

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COMMENTS (2 to date)
Barkley Rosser writes:

And does the Joker have anything to contribute here?

Peter Wallison was on with Brian Lamb last night:

WALLISON: [Fannie and Freddie] practice a very tough business in politics, very tough on individuals who are critics. And a critic could get in a great deal of trouble. There were people whose careers had been ruined by criticizing Fannie Mae and Freddie Mac.

And I personally happen to be very fortunate that I’m working at a place like the American Enterprise Institute, because they were not intimidated by Fannie Mae and Freddie Mac when I began to criticize those two companies, but they made a run at me in other aspects of my life, including a board of directors that I was on. And …

LAMB: Where was that?

WALLISON: I was a director of the Mortgage Guarantee Insurance Corporation, which is a mortgage insurer, and dealt regularly with Fannie Mae.

LAMB: And in what way? How would you deal with Fannie Mae?

WALLISON: Well, they guarantee, they insure mortgages that Fannie Mae makes. Fannie Mae makes a mortgage that has more than an 80 percent loan-to-value ratio. They are required by statute to have mortgage insurance for the remaining 20 percent.

So, that’s – the mortgage insurance business relies very much on Fannie Mae and Freddie Mac for much of their business.

And it came to pass that the president of this mortgage insurance company went to speak to Fannie Mae about the fact that they weren’t being selected as a mortgage insurer.

And he came back to the board meeting that I was at, and he said, ”Well, we were told that they only like to deal with companies that are friends of theirs. And with Peter Wallison on your board, we just don’t regard you as a friend anymore.”

So, I resigned, right then and there. But it is to me an example of the kind of thuggery that these companies were capable of. And they did that all through Washington, so that the media in Washington and individuals in Washington, and people in Congress who wanted to stand up to them, were under threats all the time.

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