Arnold Kling  

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The Bailout Will Lose Money, a... Frankly Fundamentalist...

1. The debate was truly awful. The financial crisis was caused by greed (McCain) and deregulation (Obama). We need energy independence. Our priority is to do everything at once (McCain). We will cut spending by spending more (Obama). We can create jobs.

Let me ignore the rest, and focus on jobs. We can create jobs by getting rid of computers and going back to carbon paper for communication and paper and pencil for arithmetic. We can create jobs by getting rid of electric motors and going back to human power to run factories. As long as wants are unlimited, you don't need to create jobs.

If the candidates were out to correct economic ignorance instead of pandering to it, the debate would not resemble last night's in any way. There was no winner. Only losers.

2. Avinash Persaud explains how what I call Method B lending was encouraged by regulators. Thanks to Tyler Cowen for the pointer.


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COMMENTS (12 to date)
George writes:

Truly, that was a dispiriting thing to watch. When a republican talks of buying homeowners out of their mortgages, the country has swung too far to the left.

John McCain's only saving grace is that Barak is an out-and-out socialist. But McCain's economic ignorance is scary.

Anthony writes:

We built too many houses. OK. This shouldn't be the end of the world. There are an infinite number of other things to do.

The main problem is no one can borrow the money to invest in labor to get those things done. Secondary to that, and forming a vicious circle, businesses are worried about future deflation making these investments unprofitable. The only thing we really have fear is, fear itself.

Frejus writes:

We can create a path towards jobs by investing in infrastructure and research. And energy independence will be the eventual goal of every nation as oil and gas production peak and decline in every country and other dirtier forms of energy--e.g. coal--also wain towards the end of the century. Biofuels, solar, etc: all imply energy independence. So it's a great goal, because we're headed there whether you like it or not.

As far as that article, I don't see anything in it that directly points the finger at regulators. Innuendo? Yes. What regulation is it referring to? Seems to point a finger without any facts to back it up.

Arnold Kling's debate observations highlight our scary situation - basic economic principles (the truths) are unknown by many/most voters. We will not see the debate analysis state the faulty econ truths spouted off by the candidates.

Reminds me of "Let those who will - write the nation's laws - if I can write its textbooks." by Paul Samuelson. The one thing this author WAS right about is the POWER, for good or bad, of the knowledge and ignorance of economics in determining our human affairs.

Of all the current debates on this blog of which economic actions will work and not work in the bail out, I remain MOST concerned with our level of misunderstanding of eonomic basics - among citizens, elected officials and the media.

The one bright spot is that principles remain steadfast solid, if we can only get people to see them.

Bill in Michigan

Dan writes:

For the first time this cycle I'm tempted to vote none of the above. I'm one of those who thinks you don't win elections by trying to be more liberal than the liberal, and the whole 300 bbl mortgage proposal just reminds me why I wasn't crazy about McCain in the first place. Let's just start calling him McNixon and get it over with.

Steve Roth writes:

Arnold: I take it you linked to Persaud approvingly.

So how does his position, emphasizing banks' "lending on the basis of an external credit rating," comport with your belief that credit ratings were inconsequential in the debacle?

I wonder if perhaps you've been responding negatively to any suggestion that regulation (in this case, of credit agencies) might be salutary, and that might taint your generally clear-eyed view of what caused this mess?

mk writes:

Arnold, I posted this over at MargRev too, but I'll ask here:

Is the solution here really more "relationship" lending, or is it more comprehensive quantitative risk analysis that takes into account, say, (1) the effect of future housing prices on risk of default on each mortgage, and/or (2) consumer wealth and income?

I thought your view was that credit rating looked like a great metric because housing prices were always going up. But they stopped going up. The shortcoming isn't the lack of a relationship, it's the lack of attention to borrower income and to the effect that housing prices have on risk of default.

I could be incredibly off base here, since I am just beginning to understand these arguments. Thanks for reading, and for your helpful explanations.

Les writes:

Credit ratings should be taken with a grain of salt because:

1) A downgrade is a self-fulfilling prophecy, so rating agencies are very reluctant to announce downgrades;

2) Credit rating agencies receive their fees from issuers of bonds, and are therefore unwilling to bite the hand that feeds them.

Alex writes:

Frejus,

Ha, people have been warning about peak oil for 150 years. Hasn't happened. I don't believe it happens, especially when it comes from the mouth of a politicians.

Also, what does infrastructure and research mean? Cell phone towers, bridges, research into fantastic bouncy rubber for new rubber balls? Those are questions that the advocates of central planning have to answer.

A

Arnold Kling writes:

Let me distinguish credit scoring from credit rating.

Credit scoring is a method of evaluating an individual borrower based on past credit history. It is a useful technique for credit underwriting. However, I think that among some mortgage lenders, there may have been an overly optimistic view of how well credit scoring performed, based on experience with rising housing markets.

Credit rating is what an agency assigns to a security. So Moody's will rate a security as AA, or what have you.

What I think Persaud is saying is that bank regulators liked credit ratings done by agencies. So if a bank originates a loan and keeps it, there is nothing tangible for the regulators to hold onto. On other hand, if I stick a AA security in my portfolio, the regulators think they have tangible metrics of the bank's riskiness.

So the regulators tend to favor securitized lending, even though it is filled with principal-agent problems that make it more risky for a bank than holding loans in its portfolio that were originated by its own employees, using in-house training and in-house incentives.

Hibiscus Monkey writes:

Frejus,

"We can create a path towards jobs by investing in infrastructure and research. And energy independence will be the eventual goal of every nation as oil and gas production peak and decline in every country and other dirtier forms of energy--e.g. coal--also wain towards the end of the century. Biofuels, solar, etc: all imply energy independence. So it's a great goal, because we're headed there whether you like it or not."

If America is headed towards energy independence anyway, it would be unnecessary and wasteful for the federal government to do so for it. If, as Adam Smith said, "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy", and energy independence is an idiotic goal (and it is), government intervention in the matter could be disastrous.

No matter the case, nothing is gained.

Ajay writes:

Yes, the debate was out and out pandering but I don't see how you can blame McCain and Obama for doing that, that's how you win elections. The problem is not the candidates, the problem is the legions of stupid voters, as Bill notes and as Bryan has tried to make clear. Ultimately, the politicians have to fight using the prevailing intellectual terrain of their time, blaming them for doing so is simply misguided. Hopefully, your next book can help change that terrain by educating voters but until then, politicians cannot tell the sordid truth to voters that they borrowed more than they could spend, when most will take it personally and then vote against them. However, there remains a fundamental difference between McCain and Obama in their overall policies. McCain is clearly more fiscally conservative than Obama- I'm not talking about earmarks which as Obama points out are not that much but for example, voting against Medicare D- and that will have real consequences. Getting back to the first point, if you really hate the pandering that's going on, rail against the stupidity of the common voter, not the politicians that recognize this and act accordingly.

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