Keeping the toothpaste in the tube

Dan Petegorsky

Today Treasury Secretary Geithner laid out a proposed new regulatory framework for the financial services sector. Key elements of the framework are both necessary and welcome responses to the systemic flaws in the current regulatory regime that have been revealed over the last year. But will they work?

We’re now in the midst of the third major crisis in the U.S. financial system to have hit in the last 20 years. The Savings and Loan crisis resulted in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which established the Office of Thrift Supervision and the Resolution Trust Corporation. The ENRON scandal gave us the Sarbanes-Oxley Act, which established a new set of management and accounting standards for publicly – but not privately – held companies.

In each case, however, new standards and regulatory regimes were set up only after the horse had left the barn and the toothpaste was out of the tube. While they addressed issues that were uncovered in the scandals that gave rise to them, they did not prevent the next round of catastrophes.

So while at first glance I’m encouraged by the proposed reforms, I also suspect that even as the new rules are being written the banks, hedge funds, etc. are already figuring out how to work around them – and lobbying the House and Senate committees to make sure whatever legislation is drafted will accommodate their new strategies. As Wall Street Watch put it in releasing a recent report:

The financial sector invested more than $5 billion in political influence purchasing in Washington over the past decade, with as many as 3,000 lobbyists winning deregulation and other policy decisions that led directly to the current financial collapse.

That’s a level of influence that’s not likely to stop.

Am I being overly cynical? One way to begin breaking the connections between the Wall Street money and DC policymakers is to support the Federal bill establishing a system of public financing for Congressional elections – the Fair Elections Now Act being introduced in the Senate next week by Sens. Dick Durbin (D-Ill.) and Arlen Specter (R-Pa.). It would make a perfect complement to the reforms Geithner laid out this morning.

Comments

  • Bill Holmer (unverified)
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    Why Not a Progressive Corporate Income Tax?

    In response to anti-competitive concerns from the Federal Trade Commission, formerly Oregon-based Georgia-Pacific Corporation formed a new corporation and distributed the assets of what was to become Louisiana-Pacific Corporation to the shareholders of Georgia-Pacific. Since 1973, both companies have operated independently with separate boards of directors. Might this transaction be a prototype solution to get us out of the “too big to fail” mess in which we find ourselves?

    Our current corporate income tax structure does not encourage such spin-offs. The corporate income tax rate is only progressive at the very lowest end of the scale. The 15% corporate income tax rate applies to the first $50,000 of corporate income and peaks at 39% for corporate income over $100,000, before dropping back to 34% for corporate income over $335,000.

    What we need is a truly progressive corporate income tax regimen that would encourage large corporations to spin-off operations into separate and independent corporations. The change should be revenue neutral, with corporate income tax rates gradually increasing from 15% for the first $50,000 of corporate income to say, 45% for corporate income over $50 billion.

    Some companies would choose to split themselves up to gain a lower tax rate. Others would continue to make acquisitions in order to get true economies of scale.

    Some corporate executives know that they can justify higher levels of compensation if they make big acquisitions. Unfortunately, the corporate landscape is littered with failed acquisitions. Federal tax policy should discourage these “bigger for bigness’ sake” acquisitions.

    The benefits of such a progressive corporate income tax system would be numerous. Smaller businesses tend to create more jobs. Smaller businesses tend to be less bureaucratic and more customer friendly. Corporate spin-offs would tend to increase competition. It would reduce the political influence of corporate behemoths. And perhaps most importantly, it would help get us out of the “too big to fail” dilemma.

  • mp97303 (unverified)
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    You might, or not, be surprised at the amount of lobbying going on to rip the guts out of SOX right now.

    Granted, government is always a day late to the party, and then responds in an excessive manner, but the primary elements of SOX are needed and must be preserved.

    I can guarantee that if SOX is destroyed, another Enron is just around the corner.

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    So here's the irony about Sarbanes-Oxley in relation to the crisis we face today: Sarbanes-Oxley passed in 2002. But several years before, the Clinton Administration and Congress lit the fuse for the current crisis first by repealing the Glass-Steagall Act in 1999, and then in 2000 via the Commodity Futures Modernization Act, which prevented necessary regulation of derivatives.

    So - whatever the benefits of Sarbanes-Oxley, before it was even contemplated (indeed, before the ENRON scandal even broke) Wall Street had already cut the deals that led to the next collapse. And the collusion of the ratings agencies in supporting the "financial instruments" that led to the recent collapse are uncomfortably parallel to the role that the major accounting firms played in certifying ENRON et al.'s books, concealing the accounting shenanigans/crimes of that period.

  • mp97303 (unverified)
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    Dan

    You are spot on with the ratings agencies. They seem to be avoiding the firestorm of public rage, at least so far.

  • Bobby Fisher Stockings From the Chappaquidick (unverified)
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    I have a meta question. How does one legislate that they are not setting out to destroy the system, that they won't continue do adapt methods to successfully accomplish that? "They're" in the end game. This is not an easy position to intercept.

    I suck in the end game in Chess. You need a pretty brilliant strategy to counter the material advantage. What are the actionable points?

  • Zarathustra (unverified)
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    Amen on the rating agencies!

  • Prescott Bush (unverified)
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    An untold part of the Enron story is all those execs that refused to go along and are still SOL on the job market. We're the chronically unemployed now. Where's the relief?

  • Rob (unverified)
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    The accounting regulations completely missed valuing derivatives for public companies. Update needed. Private placements of derivatives onto the balance sheets of public companies should be reported, not just OTC.

  • (Show?)

    refused to go along and are still SOL on the job market

    Partly in response to retaliations against ENRON whistle blowers, Sarbanes-Oxley included protections for whistle blowers (again, only for publicly traded companies).

    That said, whistle blowers need someone to blow the whistle to - a responsive management or agency that will take in the information, investigate and then act accordingly. But as we've learned from, for example, the Madoff case, whistle blowers too often go unheeded: Harry Markopolos tried for years to alert the SEC and others to Madoff's Ponzi scheme, to no avail.

  • rw (unverified)
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    When I was ready to blow the whistle on the local large healthcare non-profit I just exited, I was carefully counseled by folks who are advocacy and other-PC professionals that overwhelmingly, when whistleblowers are interviewed later, nearly all of them regret it. Not because of lack of integrity: it is because of the ruination of their lives. A little bit of public approbation (if that is indeed forthcoming) does not counterbalance all of the negatives of stepping up.

    I've not been perfectly silent (hence, SAFE), as it's not in my makeup to sit still for wrongdoing, nor am I psychodynamically disciplined enough to keep my mouth shut so as to protect myself. I am still just a little too mad and disgusted! But I'm getting it under control. Nobody really cares, ultimately: and I"m the only one who would be hurt even if much of anyone really did care.

    Daniel Pete is right - an Act or Mandate does not make much difference if there's no Agent or Money to back them.

  • rw (unverified)
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    Off-topic moment here: "While we're strong believers in free speech, we reserve the right to delete comment spam or other offensive material. Our contributors, however, reserve the right to embarass themselves in public."

    Kari, this one cheers me up every time. You never remove spam, and contributors regularly show their asses. Me included.

    ;)... what a cheerful little moment this was.

  • Bill McDonald (unverified)
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    A new regulatory framework for the financial services sector?

     Great idea, and thank God we got out in front of this before anything bad happened.
    
  • Idler (unverified)
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    several years before, the Clinton Administration and Congress lit the fuse for the current crisis first by repealing the Glass-Steagall Act in 1999

    How did the repeal of Glass-Steagall "light the fuse"?

    Also, I notice more and more people are bringing up the rating agencies but with a paranoid interpretation (that appears to be the case with Dan, but it's not clear that it is with the others. In Zarathustra's case, it's a safe bet).

    The rating agencies are indeed a huge part of this that has not received sufficient attention. One can make several arguments about conflicts of interest on the part of the raters, but collusion did not cause their disastrous ratings. Faulty assumptions did.

    I repeat: this is a huge part of the crisis that has not been emphasized enough, but it is more the result of the illusion of scientific evidence in the form of risk modeling. The risk models are excellent instruments and work very well for many purposes. However, people in financial services have failed to appreciate two things. First, risk models only gauge probability. Probability is not reality. As obvious as that sounds, this misunderstanding has wrought a great deal of havoc, and not only in the present crisis. Second, risk models may work perfectly but they are utterly dependent on the validity of the assumptions they compute from.

    In this regard, the raters, as well as the risk managers at AIG and the banks, were subject to the same wishful thinking as consumers who rolled the dice on variable rate mortgages. (Yes, I know some got bad advice.) All banked on the continued rise of residential real estate prices.

    What is entirely missing from Dan's post is that regulation and other forms of government interference also had a huge role in the crisis. In other words, regulation was a big part of the problem, so one must be very careful in applying regulation as a solution.

  • Idler (unverified)
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    I have a meta question. How does one legislate that they are not setting out to destroy the system, that they won't continue do adapt methods to successfully accomplish that? "They're" in the end game. This is not an easy position to intercept.

    I have to comment on this too. Does the person writing this realize that AIG has been in business since 1913 and was destroyed by what happened here? Several of the most successful financial companies, enterprises that had been aggressively trying to make money for many decades are suddenly out of business. This crisis destroyed them. That ought to be enough to tell you that this was not business as usual, and the longevity of the companies shows that they were not in business to "destroy the system."

  • LT (unverified)
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    Idler, Clinton signed a Republican bill he should not have signed. For further answer to your question,

    http://www.npr.org/templates/story/story.php?storyId=102325715

  • (Show?)

    Kari, this one cheers me up every time. You never remove spam, and contributors regularly show their asses. Me included.

    Actually, we delete the true spam all the time. What you're seeing is the stuff that slips through the cracks!

  • (Show?)

    How did the repeal of Glass-Steagall "light the fuse"?

    It marked the success of those pushing for an end to restrictions that, well, kept banks as banks, and allowed for the creation of the mega-financial services behemoths merging banking with insurance companies and securities and investment firms. Think Citigroup.

    A pithy summary is here.

  • Leo (unverified)
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    The hucksters will always be a step ahead of the regulators. There are just more financial tricksters than there are regulators, and they are more highly motivated because they only need to score big once in their lifetime. The key issue is really containment. How do you keep the influence of the crooks small enough so that they can’t take the whole system down?

    I think the most effective regulation would just limit the size and influence of these financial giants. These giant corporations don’t really produce anything, and whatever benefits they bring to the citizens of this country is much smaller than the risk they bring.

    I’m all for people having the widest possible range of economic and individual liberties. I’m even inclined to think that privately owned companies (the type where the owners put their own money and livelihood on the line) should be only lightly regulated. However, corporations (legal entities sponsored by the government through favorable laws) only exist at the pleasure of the state, and they should be treated as such.

  • Idler (unverified)
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    Dan, I know Glass-Steagall did that. My question is how that "lit the fuse"?

    These statements always amuse me:

    These giant corporations don’t really produce anything, and whatever benefits they bring to the citizens of this country is much smaller than the risk they bring.

    Does a doctor "really produce" anything? A plumber?

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    Idler - so you're asking me to explain my metaphor?? Whatever.

  • Idler (unverified)
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    Dan,

    My question has nothing to do with the metaphor.

    Unless I've missed something, all you've done is identify what the repeal of Glass-Steagall was. You haven't said anything about how it actually caused the financial crisis.

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    It was a if not the key step leading to the removal of regulatory restraints on the financial services sector. It provided firms like Citi with the (lack of) rules they needed to unleash the schemes that brought us to where we ware today.

  • Idler (unverified)
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    Dan, what "schemes" did Gramm-Leach-Bliley allow? Maybe the Commodity Futures Modernization Act would be a better culprit for the kind of thing you're thinking of.

    But even in that case, it wasn't the instruments so much as A) the bad debt, and B) the disastrous failure to properly identify the risks associated with that debt (hence my comment about the rating agencies above).

    What do you make of the government "schemes" that influenced the creation of the debt at the center of the crisis? Again, regulation didn't prevent this crisis so much as precipitate it. That doesn't mean that we couldn't benefit from some regulations, but they have to be the right ones in the right places.

    People talk a lot about AIG, but in fact the insurance industry is a good example of how good regulation can prevent crises from getting out of hand. Insurers have very high solvency requirements, which limited their exposure. AIG, in case someone out there is still unfamiliar with the fact, was operating outside the realm of insurance and its regulators when it came to credit default swaps. It was a non-insurance unit that brought the company down.

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    It was a non-insurance unit that brought the company down.

    Exactly. And it was the deregulation we're discussing that allowed firms like AIG to mix together banking, insurance, investments, etc. outside of their historical realms, right? The "bad debt" precipitated the crisis to an enormous degree because, unlike traditionally structured mortgages, insurance, etc., that debt was nowhere near sufficiently collateralized, and the leverage these firms operated with was, what, something like 30-1?

    I'm just wondering what regulations you see as having precipitated the crisis?

  • Idler (unverified)
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    Dan,

    I don't think that Glass-Steagall would have prevented AIG from making credit default swaps. Glass-Steagall was meant to prevent commercial banks from over-speculating with their depositor's money. As far as I know, AIG was never affiliated with any bank. Furthermore, while credit default swaps were not regulated by the insurance industry and were not technically insurance, they nevertheless do engage many of the core competencies of insurance operations.

    It's always worth bearing in mind that Gramm-Leach-Bliley was one bit of deregulation in an industry that remains enormously regulated, probably more regulated than any industry that ever existed. Glass-Steagall was thought by many to be an overreaction, and Gramm-Leach-Bliley was largely an effort to be more like European competitors. The "Modernization" part of GLB meant, in essence, "catching up to the Europeans." That's true of the opening for banks and securities companies. It was also in the case of CDOs, where a market had been growing in London for some time. Someone put it to me this way: "since these were multinationals it was about ensuring that they'd employ people in New York rather than London."

    Leverage was another factor, but it is secondary to the existence of really bad debt and the failure to recognize that it was bad. That goes back to the point of the rating agencies and the risk managers/modelers of the companies taking on the risks. That was a combination of wishful thinking and being "blinded by science," so to speak.

    The Europeans were even more susceptible to that misplaced rationalism. They were even more highly leveraged, again, because faulty use of risk modeling made them think their leverage ratios were mathematically sound. Nothing wrong with the models; everything wrong with the assumptions and the blind faith fostered by the appearance of rational control.

    Without the terrible risk management, AIG would likely have been fine, as would many other companies embraced within the larger picture of the financial crisis.

    Government interference in the housing market made all of this possible. The greatest prerequisite of the crisis was manipulation of interest rates by the Federal Reserve (created by the government and an instrument of government policy). The Credit Reinvestment Act set the stage to lower the standards of mortgage lending, particularly after modifications made during the Clinton administration. Banks were under pressure to lend to everyone, and both Democratic and Republican administrations pandered to the "American Dream." The establishment of the GSEs (Fannie Mae and Freddie Mac) provided a market for the collaterization of debt, much of it ultimately to turn sour. Ordinary private sector companies sold bundled mortgages to the GSEs; private sector companies were also in the CDO market.

    This was a profitable business as long as housing prices rose. They did rise, long and steeply, because government policy had pushed so many parties into the market who would never have been there otherwise. The two things fed each other and followed the chronology of government policy on housing. The unsustainability of this behavior was masked for far longer than it otherwise would have been precisely because of the artificially low interest rates and the expanding bubble caused by there being greater demand than the market would support without coercion and perverse incentives.

    Interestingly, the Bush Administration called for greater oversight of the GSEs from early in that president's first term owing to what then Treasury Secretary John Snow warned was the "systemic risk" that the organizations potentially posed.

    Again, it's not that regulation is inherently good or bad; it's a matter of having the right regulation in the right place. It's worth repeating: the financial services industry, despite GLB, is still an enormously heavily regulated business.

  • Bill McDonald (unverified)
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    I would recommend reading "The Big Takeover" article - available online - by Matt Taibbi of Rolling Stone magazine. Idler, this was the result of financial instruments that were not regulated at all. Every attempt was made to get outside the scope of regulation and once instruments like insurance policies on the derivative swaps, etc...were pulled from the asses of these greed-driven maniacs, they raced to blow up the financial universe. If you don't know who Joe Cassano is, for example, read this piece. It explains what happened but avoids the phony expert trip.

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    OK, Idler – now I see where you’re coming from.

    I agree with you on one point: monetary policy did drive interest rates down to the point where the financial industry giants had to invent ever more exotic products to market that offered marginally higher rates of return off of “safe” investments. This American Life’s segment on The Giant Pool of Money explains this process brilliantly – and many of the key players are now under investigation for a range of fraudulent and criminal practices.

    But the idea that this process was caused by the Community [sic] Reinvestment Act would be laughable if it weren't so sinister. In fact, CRA helped introduce standards in lending that made CRA regulated loans safer not riskier that those not regulated under CRA guidelines.

    First, let’s understand that CRA rectified decades and decades of discrimination in lending that enriched (predominantly white) lenders while robbing (predominantly black and rural) borrowers of their own potential wealth and creating the areas of concentrated poverty we call ghettos.

    Second, the institutions primarily responsible for the boom/bust in subprime loans were not those that fell under CRA, but the investment banks and unscrupulous mortgage brokers.

    There are many sources on this, but a short and excellent one is a McClatchy article from last fall, Private sector loans, not Fannie or Freddie, triggered crisis. Some key points:

    [O]nly commercial banks and thrifts must follow CRA rules. The investment banks don't, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans.

    According to Federal Reserve data:

    More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions. Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year. Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law [CRA] that's being lambasted by conservative critics.

    So – we’re clearly not going to agree here, since your version of the facts doesn’t match the history and facts as I understand them.

  • Bill Bodden (unverified)
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    Am I being overly cynical?

    Not in the least. However, much better than cynicism is skepticism that is overwhelmingly called for these days.

    We have, theoretically, a Constitution that is the core of our government, but it was shredded by the Bush Administration with the complicity of people on both sides of the aisles in Congress while the people slept.

    Congress passed laws and regulations to protect the nation, but at the behest of their campaign donors they repealed some (Glass-Steagall, for one) or rigged the system so that a fox would be assigned to guard the hen house. Consider Christopher Cox who was assigned the task of ensuring that the SEC would not enforce regulations that would upset Wall Street and accomplished his mission so well that he was a major, if forgotten, player in the current financial mess.

    So, what's the point in having rules and regulations if the people in charge are not going to enforce them?

    We're paying Congress for this?

  • Idler (unverified)
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    Dan,

    Bear in mind that in addition to CRA, I mentioned the Fed and the GSE's.

    With respect to that larger argument, the McClatchy article has some serious weaknesses. For example, the passage you cite actually helps my argument. The institutions that you name—New Century and Ameriquest—along with Countrywide, were among the biggest sellers of mortgage debt to the GSEs!

    These companies made a lot of money through the government schemes of Fannie Mae and Freddie Mac, with whom they essentialy partnered. It was a pretty nice racket for these companies: sell riskier mortgages and sell them in turn to a government-backed entity that was more focused on increasing homeownership than making sound financial decisions.

    As I've already said, this isn't the whole picture, but it's a significant part of it, since Fannie and Freddie racked up something like $5 trillion in liabilities in a roughly $12 trillion market.

    Regarding the private sector companies that got into the mortgage-bundling business (as opposed to retail mortgage providers like Countrywide, Ameriquest and New Century), they wanted to take advantage of what appeared to be a very profitable business, and indeed was for the short term. They made faulty calculations based on the instruments' short term performance, which, as I explained above, was a result of distortion of the system: they performed better than riskier instruments should have because of the increasing home values caused by artificially low interest rates and an "unnatural" number of market participants driving up prices, i.e., inflating the bubble.

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    Idler - you're making it sound like the private sector companies were rushing in to compete in a distorted market that emerged as a result of the GSE's role, while my understanding is that during the key years when the subprime crisis reached its peak it was just the opposite: the investment banks controlled the lion's share of the market, and Fannie and Freddie - very unadvisedly - tried to recapture some of that share.

    Of course, we also can agree that the assumption of ever-increasing valuation of the underlying home prices was a fundamental cause - and, I think, ultimately not a lot different from ENRON's use (and the investment bankers' acceptance) of its own stock as collateral in the investment schemes that brought that house crashing down.

  • Idler (unverified)
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    Regarding CRA specifically, you write:

    First, let’s understand that CRA rectified decades and decades of discrimination in lending that enriched (predominantly white) lenders while robbing (predominantly black and rural) borrowers of their own potential wealth and creating the areas of concentrated poverty we call ghettos.

    What form does "discrimination" and "robbing borrowers" really mean? It means higher risks were traditionally charged higher rates. CRA coerced banks into selling mortgages with riskier terms. Here's a story of a bank recently slapped under the terms of CRA because it declined to trade in riskier instruments!

    Fannie and Freddie were pressured by the Clinton administration to start buying risker mortgages, and in 1997 the administration authorized the securitization of those instruments. The late, lamented Bear Stearns securitized nearly $400 billion of them that year, with the implied federal backing of Freddie Mac.

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    What form does "discrimination" and "robbing borrowers" really mean?

    It means literally that: redlining black neighborhoods; preventing blacks from receiving mortgage insurance; subjecting those who still wanted to try buying their own homes to criminally unscrupulous "contract lenders" who sold them homes on terms that virtually guaranteed they'd lose both the homes and any funds they put into them, etc. etc.

    I'm not that far into the book yet, but based on what I've read so far I HIGHLY recommend Beryl Satter's new book, Family Properties: Race, Real Estate, and the Exploitation of Black Urban America.

  • revtav (unverified)
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    You've all done a nice job of citing and debating various acts and legislation that led to the current "crisis" at the risk of entirely missing the point, which is can we really influence behavior with regulation? Why are we so arrogant as to think we can mitigate or avoid a so called crisis without inflicting unintended and more severe consequences as a result. The book "A Demon of Our Own Design<img src="http://www.assoc-amazon.com/e/ir?t=thew0a-20&amp;l=as2&amp;o=1&amp;a=0470393750" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;"/>", by Richard Bookstaber outlined how increasingly sophisticated financial instruments designed to reduce risk have been at the root of most if not all recent economic meltdowns (recall that CDO's and CDS's were originally conceived as risk management tools). Is complex regulation any different or more effective? Somehow we have developed the unrealistic expectation that the economic cycle of expansion and contraction can be modified to only be expansionary, with no benefit to contraction. Perhaps the presence of adverse consequences (loss of capital) without the prospect of public aid would be as effective at eliminating the compounding effect of poor decision making and mis-management in public or private companies? The question isn't (or shouldn't) be to regulate or deregulate an industry, rather to ensure that a market is free of external manipulation from any source, private or government.

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    ensure that a market is free of external manipulation from any source, private or government

    To quote that eminent economic theorist John McEnroe, "You cannot be serious!" Really. The era of market fundamentalism is over. Done with.

    Or maybe you'd like to explain, then, what we're to do about "markets" that are fatally distorted/manipulated by internal manipulation - much of it, I expect we'll eventually discover, criminal, even under its own rules?

  • revtav (unverified)
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    the era of market fundamentalism is over...

    exactly my point, it appears we agree!

    explain, then, what we're to do about "markets" that are fatally distorted/manipulated by internal manipulation

    Given your stance that "market fundamentalism is over" which markets are operating under their own rules, able to be distorted by internal manipulation?

  • btothek (unverified)
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    Dan,

    Why would greedy bankers not loan to black people? As long as they can pay back the loans it would stand to reason that a greedy banker would loan to anyone of any color, creed or orientation.

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    Why would greedy bankers not loan to black people?

    I don't understand the purpose of the question. There's nothing hypothetical about systemic discrimination against blacks in housing and lending: it's part of this country's history of white supremacy. You might as well ask, "Why would restaurant owners not serve black customers, since a paying customer is a paying customer?"

    Idler -

    Maybe I misunderstood your point or maybe we're just quibbling about definitions, with you saying (and I agree) that regulations often have unintended consequences, and me pointing to internal corruption of markets.

  • revtav (unverified)
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    Maybe I misunderstood your point or maybe we're just quibbling about definitions, with you saying (and I agree) that regulations often have unintended consequences, and me pointing to internal corruption of markets

    Dan- To clarify: I agree with your assertion that the era of market fundamentalism is over, just not that it should be. To assume a small group of people will fairly or effectively moderate a market is either naive, egotistical, or both. The Federal Reserve system has been in place for nearly a century meddling with the economic health of our country, present situation included. Are you prepared to declare it a success? Have they been able to "maintain the stability of the financial system" or "contain systemic risk in financial markets"?

    Maybe regulation in our country ought to be viewed like an open source operating system, allowing the citizens to write their own programs and regulate themselves, or are we too far removed from "rugged individualism" and "self determination"?

    As to the "internal manipulation" of a market, are you of the belief that elected officials are exempt from corruption? Anytime a person is granted power over another through regulation or other means, the door to malfeasance is opened.

    Laissez-faire capitalism is not a perfect system and some will benefit more than others, but, it provides everyone the opportunity to achieve the "American Dream" better than any system in history.

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    To clarify: I agree with your assertion that the era of market fundamentalism is over, just not that it should be.

    Well, I think you'll find yourself in a small minority, then, and the "American Dream" line and your note about some benefiting more than others is a case in point.

    For many decades Federal housing programs combined with the real estate and lending markets to systematically prevent African Americans from sharing in "the American Dream." So that market worked great - if you were white. Would you describe as "naive" or "egotistical" the struggle to enact and enforce fair housing laws that allowed non-whites to share in that dream?

  • revtav (unverified)
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    Dan-

    you'll find yourself in a small minority

    Of people who believe what?

    Some benefiting more than others is a case in point

    I wasn't equating banks lending money to people (regardless of skin color) with the "American Dream," rather the freedom that allows "all citizens and residents of the United States to pursue their goals in life through hard work and free choice." Wikipedia has more here: American Dream

    For many decades Federal housing programs combined with the real estate and lending markets to systematically prevent African Americans

    Exactly my point, again. Regulation is not the answer.

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    I wasn't equating banks lending money to people (regardless of skin color) with the "American Dream," rather the freedom that allows "all citizens and residents of the United States to pursue their goals in life through hard work and free choice.

    Please. Now who's being naive? Using your hard earned money to buy a home is the classic centerpiece of that "American Dream." Discrimination in lending is a fundamental restriction on that choice - and, along with other persistent patterns of discrimination, has allowed some people but not others to accumulate wealth, especially since home ownership is such an integral part of wealth creation in the U.S.

  • revtav (unverified)
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    Dan, how can you continue to run through the forest without seeing the trees?
    Discrimination in lending (not that I agree with it, but to illustrate the point) is not preventing anyone from buying a home, only from borrowing money. People are still free to save the necessary funds to purchase a house. If inclined they can also enter into an agreement with the seller to carry a note, or arrange for private financing, all without the need for legislation.

    Using your hard earned money to buy a home

    Borrowing is not the same as buying. The money for the purchase is not the "buyers," nor is the house, at least not until the last payment is made to the lender. Moreover, in calculating net worth liabilities must be subtracted from assets, wealth is not created by paying for an asset with a liability. The only way for a residence (without rental income) to create wealth is for it's value to increase at a compounding rate greater than the cumulative sum of all interest payments, taxes, and maintenance costs. Historically property values have increased a approximately 7% per year on average. Home ownership through debt is the great American illusion, not the American Dream. The only wealth being created in this situation is on the balance sheets of the banks.

    home ownership is such an integral part of wealth creation in the U.S.

    Adam Smith defined wealth as "the annual produce of the land and labor of the society." True wealth is a combination of production and resources. Wealth does not come from borrowing money to purchase a house and sitting idle while it miraculously appreciates.

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    I'm sorry, Revtav, but you seem to be in some kind of ideological fantasy land, not the real world. You're acting as if quoting Adam Smith negates actual statistics on wealth disparity, home ownership, etc. - kind of like, "Who you gonna believe? Adam Smith or your own lying eyes?"

  • Bill Bodden (unverified)
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    True wealth is a combination of production and resources.

    I'm inclined to believe that Bernie Madoff and others who played similar games would disagree with this statement unless you consider his phony statements as production and his marks as equivalent to resources.

    On the other hand, we might say that stolen money is not true wealth.

  • revtav (unverified)
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    I'm sorry, Revtav, but you seem to be in some kind of ideological fantasy land, not the real world. It's hard to have a chat "around the water cooler" when you fail to rebut the points being made.

    You're acting as if quoting Adam Smith negates actual statistics on wealth disparity, home ownership

    No I was saying home ownership does not equal wealth. If you have statistics, show me the numbers and we can discuss them, I estimate (without seeing your statistics) there is a high correlation between home ownership and wealth. This does not mean implicitly that home ownership creates wealth, rather people with wealth buy homes.

    "Who you gonna believe? Adam Smith or your own lying eyes?"

    The truth is what I seek, and you?

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    revtav: It's hard to take at face value that truth is what you seek when you're venturing far more into "truthiness" - for example, your bizarre attempt to argue that the purchase of homes via mortgage credit by non-wealthy individuals has somehow not been an absolutely essential ingredient in wealth creation.

    Go look at the history of what made the U.S. middle class so increasingly prosperous in the post-war period. VA and FHA loans were critical in enabling at least white middle class families to become home owners. And home ownership has been by far the greatest generator of wealth for low and middle class families.

    You say – with a straight face? – that “[d]iscrimination in lending is not preventing anyone from buying a home, only from borrowing money.” That would make your thesis that “people with wealth buy homes” a tautology, since without access to credit it’s obviously true that only wealthy people could buy homes.

    No, the truth is that historically home ownership has indeed been an if not the engine of middle class wealth creation in the U.S. The exclusion of non-whites from home ownership has been a primary factor in racial wealth disparities. And, tragically, the fact that access to credit and therefore increasing home ownership very recently among African Americans and Hispanics means that they have also been hit hardest by the sub-prime crisis.

  • Idler (unverified)
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    Idler -

    Maybe I misunderstood your point or maybe we're just quibbling about definitions, with you saying (and I agree) that regulations often have unintended consequences, and me pointing to internal corruption of markets.

    Dan, I’m not sure what you mean by the “internal corruption of the markets” and to what extent I might agree or disagree. One of the ideas I’ve tried to highlight is the mutual corruption of government and business. Another is how government’s attempt to level the playing field involved uneconomical or un-mathematical thinking. Some people simply shouldn’t have been in the housing market and CRA helped to ensure their entry. The activities of the GSEs did as well. At the best of the government, lending standards were relaxed.

    My point is by no means that “it’s all government’s fault,” but I do assert that government action is the sine qua non of the crisis.

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    Idler - we're obviously not going to agree that government action was the "sine qua non" of the crisis.

    Re. this: Some people simply shouldn’t have been in the housing market and CRA helped to ensure their entry.

    1) I've already cited above data showing that CRA-covered loans have fared better than parallel loans made by non-CRA covered lenders. In addition - and I need to look for more stats on this - if I'm not mistaken a very large percentage of the shaky loans that brought down the crisis were not to new borrowers, but represented re-financing or equity loans to existing borrowers who were, as the saying goes, using their homes as ATM machines and extending their debt to unsustainable levels.

    2) Again - the facts and history are that prior to efforts by community organizers, civil rights lawyers, etc. entire classes of U.S. citizens were denied loans not by any kind of "mathematical thinking" by a rational market but by racism, pure and simple. CRA was one of a number of legislative remedies.

    My larger point is that there are indeed "uneconomical or un-mathematical" social goods for which government is responsible, and which I don't believe the market itself will address. As another example, we have a long - and, I would argue, at least modestly effective - history of the progressive enactment of consumer safety regulations which the market itself would never have implemented by itself, and which "the market" has fought at every step - from seat belts onward.

  • Idler (unverified)
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    Idler - we're obviously not going to agree that government action was the "sine qua non" of the crisis.

    Why not? It’s not against your religion, is it?

    I've already cited above data showing that CRA-covered loans have fared better than parallel loans made by non-CRA covered lenders.

    Assuming this is right, it doesn’t negate my point. The real comparison is between loans written under standards prior to CRA and those written under standards pushed by government as as part of CRA. Those standards created new money-making opportunities for other institutions and changed the terms of competition — make these loans or hungry consumers will go to those who will. Also, as I’ve pointed out more than once, the GSEs were buying mortgages, and they relaxed their standards for which ones they would buy, meaning that originators had a ready market for loans written on riskier terms.

    if I'm not mistaken a very large percentage of the shaky loans that brought down the crisis were not to new borrowers, but represented re-financing or equity loans to existing borrowers who were, as the saying goes, using their homes as ATM machines and extending their debt to unsustainable levels.

    I have no quibble with this. It supports my contention that private individuals were also culprits, not just helpless victims.

    entire classes of U.S. citizens were denied loans not by any kind of "mathematical thinking" by a rational market but by racism, pure and simple. CRA was one of a number of legislative remedies.

    I suspect that serious analysis of the data would reveal that the discrimination was exaggerated. I say this in part because I have seen some particular claims reexamined and shown to be bogus. I also say it because it is commonplace, unfortunately, for judgments of racism to be made on the basis of outcomes that can have other causes. I say it also because prudent approaches to mortgage underwriting themselves were identified as racially discriminatory and relaxed in order to enable minorities to get loans more easily.

    However, it is dangerous to underestimate human depravity, so let’s say there was some quantity of racist discrimination in lending. Even if that were the case, it doesn’t mean that the remedies were right, realistic or safe, from a risk management perspective.

    My larger point is that there are indeed "uneconomical or un-mathematical" social goods for which government is responsible, and which I don't believe the market itself will address.

    One can argue about what the government should or should not be doing by way of providing social goods. However, that’s not my concern here. If one identifies a social good to be provided by government, one is still required to either identify an economical way of providing it, admit it’s unaffordable, or pay for it later.

  • revtav (unverified)
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    Dan: To assert that home ownership and not the habits, discipline, and ingenuity of the individual are the reason for wealth is frankly, absurd.

    Is it possible that the post WW2 prosperity had something to do with the massive industrial build up from the war and the ability to pay for housing was a result of, not the reason for the wealth?

    since without access to credit it’s obviously true that only wealthy people could buy homes

    Is it "obviously" true? What if a person saved for 15 or 20 years, accumulated the necessary funds, and paid cash?

    Another "tautology" for you: if you are buying on credit you don't own anything, the lender does. Wealth is not increased through credit. I'll try to explain it with numbers.

    Purchase Price of Home: $100,000 Down Payment: $ 10,000 Amount Financed: $ 90,000

    Net Worth of the Purchaser: Assets: $100,000
    Liabilities: ($90,000)
    Net Worth: $10,000 (The same level of wealth as before the home purchase)

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    Idler -

    Why not? It’s not against your religion, is it?

    lol. I appreciate the humor.

    If one identifies a social good to be provided by government, one is still required to either identify an economical way of providing it, admit it’s unaffordable, or pay for it later.

    I agree - though there's much room for debate about what is "economical" or "affordable."

    Revtav:

    Wealth is not increased through credit. I'll try to explain it with numbers.

    Now I know you're not being serious. If/when you pay off your mortgage, you own the house. You can leave it to your kids, sell it to pay off your medical bills when you get old, whatever. If you hadn't borrowed but instead paid the equivalent amount to your landlord(s) instead of the mortgage holder, you'd have bupkis.

    (I am, of course, speaking generally, not about "underwater" mortages, etc.)

  • revtav (unverified)
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    Dan: If/when you pay off your mortgage, you own the house.

    Are you intentionally ignoring the "cost" of borrowing money or the cost of home ownership over and above the monthly mortgage payment? At 6.50% $200,000 will "cost" you $255,088.98 in interest over 30 years, for a total of $455,088.98. This figure does not include property tax, maintenance,or insurance on the home. Nor does it address the fact that most people don't live in there homes for the duration of the mortgage which introduces a whole host of additional costs. Given the long term appreciation rate for real estate the best our hapless homeowners can hope for is a break even. If the same "renter" saved a mere $335 per month over the cost of rent, earned 8% compounded annually they would have ~$455,000 to pay cash for a house after 30 years, or to as you say "leave it to your kids, sell it to pay off your medical bills when you get old, whatever." The primary advantage to a mortgage is that it forces people to save, a discipline many do not possess.
    Wealthy people, are in fact wealthy (unless they won the lottery or inherited it) because they own assets, not liabilities. The exact opposite of what you are advocating. The expansion of credit has enslaved people to servicing debt, with the illusion of wealth. If you really want to help people build wealth, speak the truth about what actually works using examples and numbers, not legislation and rhetoric.

    Robert Kiyosaki says many things I don't agree with, but his book "Rich Dad's Cashflow Quadrant" is an excellent primer on both sides of the balance sheet.
    Incidentally, he defines wealth as "the number of days you can survive, without physically working and still maintain your standard of living."

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    OK - just one more of these and then, since no one else seems to be paying attention, it's time to close this off:

    Wealthy people, are in fact wealthy (unless they won the lottery or inherited it) because they own assets, not liabilities.

    Surely you jest. The main difference when it comes to borrowing to amass wealth is that working people put their own money/assets at risk to buy their cars, homes, etc., while the wealthy (or those with access to real wealth) are able to borrow put other people's money at risk to amass even greater wealth. That's what "leverage" is all about.

  • revtav (unverified)
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    To quote the brilliant philosopher Ron Burgundy "Agree to disagree."

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