Kevin Drum

Quote of the Day: Subprime Lending

| Mon Apr. 19, 2010 12:10 AM EDT

From 13 Bankers, by Simon Johnson and James Kwak:

Before the market for private mortgage-backed securities took off in the 1990s, subprime lending was constrained by the fact that subprime lenders wanted to be paid back.

Indeed. There is something remarkable about living in a world in which this sentence can not only be written, but actually makes sense.

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Financial Reform and American Politics

Outrage over the financial meltdown shouldn't be partisan.

| Sun Apr. 18, 2010 7:24 PM EDT

Ryan Avent has a very good brief summary of the state of play in financial regulatory reform today. It's worth a read. Be warned, however: the conference that inspired the post, he says, "has left me with a sense of resigned cycnicism."

The whole subject has left me with considerably more than that. Brutal partisan brawling over things like healthcare reform and climate change legislation was (and is) entirely unsurprising. It was the same old fights as always, and it never really left me with a feeling that politics had broken down in any real way. Financial reform is different. Politically, the obvious play for both parties is to outbid each other in efforts to rein in Wall Street, which practically everyone in America hates. But even though this would be an enormous vote getter, neither party is doing it. Democrats are offering up some mild reforms that would modify the playing a field a bit but not really fundamentally change anything. Republicans won't even go that far. Apparently motivated by industry fealty and a desire to simply oppose anything Democrats offer up, they're unwilling to support even modest reforms.

It's hard to know what to think about this. If your city were nearly destroyed by a huge earthquake, proposing better building standards would be an obvious response. It wouldn't be a left vs. right thing, it would be a property developers vs. everyone else thing. The financial meltdown of 2008 was like that. It exposed such massive fault lines in our banking system that outrage really shouldn't be a left vs. right thing. It should be a big banks vs. everyone else thing. But the intellectual and monetary hold of Wall Street on our political class is so overwhelming that it was able to turn the whole affair into just another excuse for the usual partisan bickering. The winners, of course, will be the big banks.

Ryan, I think, lets everyone off the hook too easily by saying that one of the problems is that "no one can agree on the underlying causes of this latest crisis." That's not quite right. It's true that a lot of reasons for the crisis have been offered up. Here are the ones that occur to me just off the top of my head:

  1. Housing bubble (i.e., the pure mania aspect of the thing).
  2. Massive increase in leverage throughout the financial system.
  3. Global savings glut/persistent current account deficits.
  4. Shadow banking system as main wholesale funder for banking system/Run on the repo market.
  5. Fed kept interest rates low for too long.
  6. De facto repeal of Glass-Steagall in 90s (and de jure repeal in 1999) allowed banks to get too big.
  7. Commoditization of old-school banking drove increasing reliance on complex OTC securities as the only way to earn fat fees
  8. Mortgage broker fraud.
  9. Explosive growth of credit derivatives magnified and hid risk.
  10. Overreliance on risk models (VaR, CAPM) that understate tail risk.
  11. Wall Street compensation models that reward destructive short-term risk taking.
  12. Originate and distribute model for mortgage loans.
  13. Three decades of deregulation/political economy of lobbyists.
  14. Endemic mispricing of risk throughout market.
  15. Ratings agency conflict of interest.
  16. Investment bank change from partnerships to public companies.
  17. Government policies that recklessly encouraged homeownership.

That's a lot of possible reasons. But that's not why we're stuck. Everyone agrees that skyrocketing leverage was a huge problem, for example. Everyone agrees that mortgage fraud was a problem. Everyone agrees that ratings agencies were a big problem. Ditto for resolution authority, risk models, OTC derivatives, and the instability of the repo funding model. So even if there's disagreement about some of the items on this list, there's enough agreement about the others that there should be no problem putting together a stringent bunch of new rules that take a pretty serious whack at Wall Street. After all, agreement on 70% of the big problems is actually more than you get most of the time.

But we're not getting any of this. Treasury wants to shove off leverage concerns to Basel. Ratings agencies are largely getting a pass. Mortgage fraud is getting a pass. Risk models seem beyond anyone's scope to regulate and the repo funding model, like leverage, is being punted to Basel. In the end, we might get a bit of action on resolution authority and derivatives regulation, but that's probably about it.

So, yeah: resigned cynicism. How can the entire world's financial system nearly blow up and leave practically no serious action in its wake? How can one party respond only with weak tea while the other party flatly refuses to accept even that? It boggles the mind. And yet, that's pretty much what's happened. Welcome to 21st century America.

Friday Cat Blogging - 16 April 2010

Big Brother is watching Inkblot

| Fri Apr. 16, 2010 3:05 PM EDT

On the left, Big Brother is watching Inkblot. As you can tell, he's enthralled by this gigantic televised version of himself. On the right, Domino is pretending to be a zebra. Not very well, mind you, but she's trying. And with that, I'm off to lunch and then to the Apple Genius Bar to see if they can make my mother's iPod work again.

But one other thing first: you may have noticed that it's fundraising week here at MoJo. We rely on a lot of different funding sources to keep things going around here, and our readers are one of them. So if you appreciate what the magazine does, as well as what I and the other bloggers do, we'd sure appreciate your help in return. You can donate here. Thanks!

Quote of the Day: Vampire Squid Edition

How to screw your customers in three easy steps.

| Fri Apr. 16, 2010 2:46 PM EDT

From Goldman Sachs vice president Fabrice Tourre, on January 23, 2007, as he was in the process of putting together a CDO offering that was specifically designed to implode:

More and more leverage in the system, The whole building is about to collapse anytime now...Only potential survivor, the fabulous Fab[rice Tourre]...standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!

Well, I guess he understands the implications now.

Archiving Twitter

| Fri Apr. 16, 2010 2:23 PM EDT

The Library of Congress plans to begin archiving all Twitter posts. Impressive! Except, not so much:

When do you start?
The agreement has been signed, but we still have a lot of technical details to work out — how we'll technically transfer it, and when. There's a built in six-month window, so we don't have the live Twitter archive at any given time. There is a window for people if they want to delete their tweets, things like that.

There's a built-in lag?
Yes, so once the transfer is complete, if a researcher comes here, we'll let them know that it's 2006 till six months prior. And there'll be a rolling period of transfers after that.

How much will it cost?
Well, it's a gift; we didn't pay for it. But it will be the cost of storing what is, right now, around 5 terabytes, and the staff effort of maybe one full-time person over the years.

Five terabytes of storage? Seriously? That'll set you back about a thousand bucks. Make it a fancy RAID array and maybe it's a couple thousand. They needed a gift for this?

And I learned something else new: namely that (a) Twitter's archives are remarkably small, and (b) they exist. I always figured there was no good way to search Twitter because they only kept tweets for a certain length of time. But no. They've got 'em all, and the database is so small that it could be indexed in a few hours. So why is searching Twitter so hard? And will researchers really have to "come here" to search the archives? That was left unclear at the end of the interview, but it sounds like this is Twitter's call. Putting it online sure sounds like a better idea to me.

Breaking Up the Banks

A fine idea, maybe, but who's got a plan for doing it?

| Fri Apr. 16, 2010 1:10 PM EDT

James Bullard, president St. Louis Fed, says breaking up big banks is a good idea in theory:

“If you had a clear road map, I’d be for it,” Bullard said Thursday at the Hyman P. Minsky Conference in New York. “If there was a good way to do so, if you had a clear road map about how you were going to go about it, and why you were going to break them up in this particular way.”

Matt Yglesias is "frustrated" by statements like this: "I suppose I agree with that, but 'how' is not a minor issue here. The country would really benefit from one or more of these guys — who, after all, have some real expertise and credibility in the field of bank regulation — developing some kind of more specific idea that could then be subjected to specific scrutiny and/or gain support."

I think this is unfair. If you read Bullard's remarks, he's basically saying that he's not really sure there is a practical way to do this. That's a perfectly reasonable stand to take. There are lots of things that are good in theory but hard to implement in practice, and sometimes that's the right thing to say about them.

As it happens, my primary objection to spending energy breaking up big banks is that I'm just not sure it would really fix anything. Blanche Lincoln, for example, has floated the idea of forcing big banks to spin off their derivatives trading operations. Sounds good! And from a prudential point of view, it really might be a good idea. But from the point of view of bank sector profitability and political power, I'm not sure what difference it makes. The danger of derivatives abuse would still be there and would still pose systemic danger, it would just emanate from a different source.

Still, this is quite possibly the right approach if you really do want to break up banks. Instead of placing an arbitrary cap on assets, regulate what businesses they can be it. If a single firm could only engage in (pick one) commercial banking, investment banking, trading on their own account, derivatives underwriting, insurance, or private equity, that would force a radical downsizing. Add in a requirement that capital requirements go up along with size, and individual actors even within single sectors would have a strong incentive to stay small. I don't know for sure that this would be the best approach, but it's at least feasible. And while I don't think Bullard has any obligation to flesh this out, the folks who are dedicated to breaking up the banks probably do. Not in mind-numbing detail, but at least in enough detail to explain how it would work in the real world.

In the meantime, I'd rather have ten big banks with serious leverage constraints than 50 with weak constraints, and there are plenty of good proposals for how to accomplish that. All we lack is the political will to get it done. Maybe the SEC's suit against Goldman Sachs will wake up a few people and help put a little steel in their spines.

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Victimology? Seriously?

Marriage is the goal, but intermediate steps will help us get there.

| Fri Apr. 16, 2010 12:38 PM EDT

Andrew Sullivan:

You'd have to have a heart of stone not to applaud the president's attempt to ensure that gay spouses have access to one another in hospital settings. Equally, the dynamic leaves me queasy. There is something about the well-meaning liberal mind that is often admirably eager to help the needy, but balks at offering the recipients what we really want: simple equality. The latest move — giving Obama an easy win, the gay lobby a role in mediating the transaction — perpetuates the victimology that sustains the Democrats and their interest groups.

"Well meaning liberals" have almost unanimously been fighting in favor of gay marriage for years. We aren't balking at anything. But in the meantime, surely incremental change is better than nothing? Seriously: Does Andrew really think that those of us who support progress short of complete victory are merely interested in "perpetuating the victimology that sustains the Democrats and their interest groups"? For God's sake.

SEC Sues Goldman Sachs

Deliberately screwing your customers is not OK.

| Fri Apr. 16, 2010 11:30 AM EDT

This is an unusually pleasant way to start my morning:

Goldman Sachs, which emerged relatively unscathed from the financial crisis, was accused of securities fraud in a civil suit filed Friday by the Securities and Exchange Commission, which claims the bank created and sold a mortgage investment that was secretly devised to fail.

....The instrument in the S.E.C. case, called Abacus 2007-AC1, was one of 25 deals that Goldman created so the bank and select clients could bet against the housing market. Those deals, which were the subject of an article in The New York Times in December, initially protected Goldman from losses when the mortgage market disintegrated and later yielded profits for the bank.

As the Abacus deals plunged in value, Goldman and certain hedge funds made money on their negative bets, while the Goldman clients who bought the $10.9 billion in investments lost billions of dollars.

Goldman claimed that the securities bundled into Abacus had been chosen by independent managers, but in fact they'd been carefully cherry picked by hedge fund manager John Paulson, who selected the crappiest mortgage bonds possible because he wanted to bet against them. Goldman apparently thought that was a fine idea, because they wanted something to bet against too. So a synthetic CDO purposely designed to do poorly seemed like a great idea.

But Goldman wasn't the only one. Hopefully this is just the first SEC suit of many.

The 4,543 Word Tax Code

It's the tea partiers' most humorous idea yet.

| Thu Apr. 15, 2010 10:18 PM EDT

A conservative umbrella group called "Tea Party Patriots" unveiled its Contract From America today, composed of items that were the top ten vote getters from their members. Here's my favorite:

4. Enact Fundamental Tax Reform

Adopt a simple and fair single-rate tax system by scrapping the internal revenue code and replacing it with one that is no longer than 4,543 words — the length of the original Constitution. (64.90%)

I have to admit that I like the symbolism of the 4,543 word limit, but what I'd love is to see one of these geniuses actually write a modern tax code that length. And when they're done, I'd like them to build a 747 using instructions no longer than those used to build the USS Constitution.

And that's that. With this little bit of snark I've gotten through Tax Day without writing a single post about tax rates, tax shares, income tax vs. all federal taxes, who does and doesn't pay taxes, whether people know how much they pay, or anything else related to the barrage of tax nonsense that assaults us annually on this day. Can't we just celebrate the birth of Leonardo da Vinci instead?

Birchers Yesterday, Tea Partiers Today

The wingnut lineage of the modern tea party movement.

| Thu Apr. 15, 2010 7:37 PM EDT

I've had several conversations recently about the damage the tea party movement has done to political discourse, and I've generally taken the position that, bad as they are, we've seen it all before. Compared to the red-baiters of the 50s, the Birchers of the 60s, and the Clinton paranoids of the 90s, it's just more of the same.

But I'm not entirely sure of myself on this score. Maybe they are worse. And so I've thought, "I should call Rick Perlstein and chat with him about this. He'd know." But now I don't need to, because here he is in the New York Times today:

“When was the last time you saw such a spontaneous eruption of conservative grass-roots anger, coast to coast?” asked the professional conservative L. Brent Bozell III recently. The answer, of course, is: in 1993. And 1977. And 1961. And so on.

And so yet much of the commentariat takes Bozell at his word, reading what is happening as striking and new. I’ve studied the reactionary florescence of 1961-1962 most closely (I wrote about it in “Before the Storm”), and the parallels are uncanny.

The same “spontaneous eruption” of folks never before engaged in politics. (“I just don’t have time for anything,” a housewife told a news magazine. “I’m fighting Communism three nights a week.”) The same blithely narcissistic presumption that the vast majority of Americans (or, at least, “ordinary Americans”) must already agree with them, and incredulity that anyone might not grasp the depth of the peril....The same lunatic persecution fantasies. (In Robert Welch’s 1961 it was probable internment camps for conservatives. In Glenn Beck’s 2009 it was ... probable internment camps for conservatives.)

OK, I'm convinced. In fact, one of the most intriguing findings of the Times poll of tea partiers confirms Rick's suggestion that they're convinced that the vast majority of Americans agree with them. Take a look: a stunning 84% of tea partiers believe their views "reflect the views of most Americans." Virtually everyone else disagrees. But why shouldn't they believe that? If you watch Fox News all day and listen to Sarah Palin telling you that you're just a "common sense conservative," you'd believe it too. It's an alternate universe out there.