mf - story #4574 - No argument here. Th

posted by rick on October 7th, 2008 at 8:09PM

No argument here. That's consistent with some articles I've come across. Specifically, http://query.nytimes.com/...on=&pagewanted=1 this one about Fannie Mae responding to pressure from the Clinton Administration to lend to low-income borrowers.

I'll bring up another http://www.nytimes.com/20...n01NhrLJAjQLHx5V w&oref=slogin article though. The investment banks successfully pushed to remove regulation that dictated how much money they had to keep in reserve to buffer against losses from failed investments. So the banks have to accept some of the blame as well.

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posted by dsk on October 8th, 2008 at 12:26AM

>The investment banks successfully pushed to remove regulation that dictated how much money they had to keep in reserve to buffer against losses from failed investments.

Ok. So now you explain to me how being allowed to hold a lower reserve of cash makes banks issue irrationally risky loans. I can't see a correlation between the two. In fact, I could make the case that it should make banks more prudent.

Anyway, the most I could say is that they would have less money to throw around on bad loans - which might have meant an eventual bailout of $500 billion, instead of $700 billion. But it doesn't address the fundamental issue I had with your reasoning. Mainly why banks would exhibit irrational behavior in the form of lending to people that have little chance in paying those loans back (and all this with full knowledge that house prices were not going to go up forever), in the first place. The answer to this question has nothing to do with deregulation, and almost certainly implies market distortion.

Deregulation might have increased the eventual losses only by the happenstance of coming about during a time of this distorted behavior but clearly, could not be the root of the problem itself. With or without deregulation we were heading towards this crash.

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posted by rick on October 9th, 2008 at 4:32AM

The problem is two-fold: The banks had more capital to dump into failing investments, thus digging themselves into a bigger hole; and they no longer had the reserve to guard against failing investments. It's hard to say how much it would have helped, although I don't believe it would have required $500 billion to fix. Heck, I don't even know where the $700 billion figure came from.

As for why banks would take on risky investments, subprime loans charge higher interests, which generate more profit for them. And as you said, as long as housing prices kept rising, it didn't matter that some borrowers couldn't afford the loan, because they could simply foreclose and sell the house at a higher price for a profit. The banks saw this trend and tried to capitalize, but they couldn't predict when this trend would stop in time.

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posted by dennisn on October 9th, 2008 at 10:08AM

Ricky, are you a part of the government-can-do-no-wrong crowd that was mentioned in one of those articles? :P.

(A: Yes. Wake up!) :D.

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posted by rick on October 9th, 2008 at 4:51PM

I don't think anyone is in the government-can-do-no-wrong crowd at the moment. But I'm not in the government-can-do-no-right crowd either. :)

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Well, you seemed to be suggest by dennisn on October 9th, 2008 at 5:30PM.

>If we didn't have the balls t by story on October 9th, 2008 at 6:35PM.

If you can somehow say, with a by dennisn on October 10th, 2008 at 11:54AM.

posted by dsk on October 9th, 2008 at 9:39AM

>thus digging themselves into a bigger hole

In which they were already in (or going to be in). I argued that this has nothing to do with the central problem. The hole is already there - why is there?!

>As for why banks would take on risky investments, subprime loans charge higher interests, which generate more profit for them.

Profit is not enough. There's a reason why banks don't take their money to casinos and bet it all on blackjack. The potential profits are staggering but the risk of losing everything is huge. And that's my point.

>The banks saw this trend and tried to capitalize, but they couldn't predict when this trend would stop in time.

This is what doesn't make sense to me. You can't possibly expect me to believe this. Sure, they couldn't predict when this trend would stop, but they knew it would. Everyone knew what was happening to home prices was a bubble that was going to burst. The few years before the housing bust, everyone was just waiting for it to collapse. You think forecasters couldn't see it coming?

So that's the contradiction, or rather evidence of market distortion. They lend money out, knowing full well that there is good chance they won't get it back. This is irrational behavior, which makes sense only when you bring government into the mix, who via the quasi-governmental banks of Fannie Mae and Freddie Mac, in essence guaranteed the subprime loans (not to mention the fact that they pushed for them to happen in the first place).

I will gamble all my savings in a casinos if you tell me you'll reimburse any loses I incur. In this situation, in fact, the most rational action for me to do is play the games with the highest rewards (and therefore the highest risk). At the root of it, that seems to be essentially what happened.

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posted by dennisn on October 7th, 2008 at 10:24PM

No. The the banks did not behave recklessly. They knew they had government backing, and thus could safely take on far more risk than a free market would possibly have allowed. In an unregulated environment, they would have risked being unemployed, and thus would have self-regulated themselves. With government intrusion, essentially none of these risks or signals are relevant.

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posted by dsk on October 9th, 2008 at 9:56AM

>Housing prices were rising, which makes subprime mortgages essentially a non-risk

Oh come on. I'm 100% sure Banks didn't think this way. These Banks that were in business for decades through many market cycles. These Banks also issued mortgages that would last decades. It is a huge risk to believe that house prices would go up /at the level that they did/ for long enough time for them to break even. House prices were going up in Canada too. Ontario was going through a boom. Alberta housing market was exploding, but you didn't see Banks going crazy, lending money to anyone that asked. Why? Because they didn't an implicit agreement that government would guarantee subprime loans. They didn't have government pushing them to make subprime loans. They didn't have Fannie and Freddie.

>A lot of these loans were bought out by Freddie and Fannie afterwards anyway, so the original lenders didn't have any risk.

There it is. It's not the fact that house prices were going up that was the problem. It's the fact that lending to a particular high-risk high-reward demographic, carried no risk - which rationally promotes that action. You want to engage in high-reward behavior if the risk is removed.

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posted by rick on October 9th, 2008 at 5:02AM

Yes and no.

The banks knew they could safely take on the risk, because of two reasons:
- Housing prices were rising, which makes subprime mortgages essentially a non-risk
- A lot of these loans were bought out by Freddie and Fannie afterwards anyway, so the original lenders didn't have any risk. And Freddie and Fannie was backed by the government, so you are correct there.

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