Learning from Europe while it is , in effect, on a gold standard

[DSGE]

Mark to market accounting caused the housing bubble (and it probably will again), not inflation.

How do you figure?

Easy - the banks were fine with lending more of our money at favorable rates as long as housing prices went up and housing prices kept going up as long as banks continued to lend money at favorable rates. FAS 157 was (truthfully) *imposed* on Fannie and Freddie in '06 and was widely used before that. The problem wasn't really that people were buying more house than they could afford. The problem was simply that house prices were falsely high because the positive feedback loop created by FAS 157 made home ownership unreasonably expensive. That is the root cause and all the problems that came afterward, from obscene bankers bonuses to the subprime derivatives crashing the investment banking sector to the high unemployment rate - it all traces back to FAS 157.....


.... which is still the accounting standard used. But it doesn't matter because the housing market sucks. If it ever recovers we'll be screwed again.

I don't get what feedback loop you're talking about. Or how it made home ownership "unreasonably expensive" (or why "unreasonably expensive" home ownership would make the housing market crash). Also credit didn't crunch until a full year after house prices started to tank. The bubble popped in mid 2007. Credit fell in 2008 around the time Lehman went under.

 

[samjones]

I don't get what feedback loop you're talking about. Or how it made home ownership "unreasonably expensive" (or why "unreasonably expensive" home ownership would make the housing market crash). Also credit didn't crunch until a full year after house prices started to tank. The bubble popped in mid 2007. Credit fell in 2008 around the time Lehman went under.

Unreasonable home prices were a symptom of the bubble. The crash was inevitable. The positive feedback loop of mark to market accounting simply determines that a home is worth something simply because a similar home was sold for the same amount. Sounds sensible, but in the past banks would look at historical trends for that valuation. Banks were willing to lend to much money because other banks were lending too much money.

Credit markets failed within the year (really the handwriting was on the wall when Bear went down) because ultimately people figured out that these bad packaged loans just weren't going to become good.

 

[DSGE]

I don't get what feedback loop you're talking about. Or how it made home ownership "unreasonably expensive" (or why "unreasonably expensive" home ownership would make the housing market crash). Also credit didn't crunch until a full year after house prices started to tank. The bubble popped in mid 2007. Credit fell in 2008 around the time Lehman went under.

Unreasonable home prices were a symptom of the bubble. The crash was inevitable.

What do you mean unreasonable? The price of homes is determined by the supply of and demand for houses. One thing affecting the current demand for houses is their expected future price. If people expect the price of houses to be permanently higher next year, they'll want to buy this year. If people expect that in three years the price of housing will fall back to its trend level, nobody will enter into a contract where they're paying more over the next 20 years for a house than what it'll be worth. There was so much demand for housing because home prices were expected to be high permanently. Do you have some mechanism through which mark-to-market managed to trick people into believing that house prices would be persistently high?

The positive feedback loop of mark to market accounting simply determines that a home is worth something simply because a similar home was sold for the same amount. Sounds sensible, but in the past banks would look at historical trends for that valuation. Banks were willing to lend to much money because other banks were lending too much money.

Right so a mortgage on a bank's balance sheet would be valued at the market price, which was very high, because other banks were making credit available to allow people to demand housing. Even that doesn't make a lot of sense, but I'll put that aside for now. It's irrelevant because banks didn't hold mortgages on their balance sheet. They securitized them off their balance sheet quickly. Those mortgages then got turned into CDOs which were difficult to accurately value, though that didn't stop the credit rating agencies giving them AAA. Banks did hold CDOs on their balance sheets but how are you gonna value them? It was a reasonably new instrument; not exactly extensive historical trends to go on.


I don't see how mark-to-market played any roll in this. I mean the magnitude of the downturn was caused by tight monetary policy anyway, not the financial crisis, but I don't even see how m-t-m played a part in that. Lending and borrowing is determined by the expected future price, not just the current price. This whole thing is more easily and sensibly explained by incentive problems associated with securitization, new credit instruments that we didn't really know how to deal with, incentive problems in the credit rating industry resulting in those instruments being deemed default risk free, and the Fed letting NGDP drop.

 

[sparky]

Everything You Need to Know About Wall Street, in One Brief Tale | Matt Taibbi | Rolling Stone

From the Atlantic story by reporter Teri Buhl:

The traders were essentially double-dipping -- getting paid twice on the deal. How was this possible? Once the security was sold, they didn't have a legal claim to get cash back from the bad loans -- that claim belonged to bond investors -- but they did so anyway and kept the money. Thus, Bear was cheating the investors they promised to have sold a safe product out of their cash. According to former Bear Stearns and EMC traders and analysts who spoke with The Atlantic, Nierenberg and Verschleiser were the decision-makers for the double dipping scheme.

Imagine giving someone a hundred bucks to buy a bushel of apples, but making a deal with him that he has to buy back any apples that turn out to have worms in them. That's what happened here: Bear sold the wormy apples back to the farmer, but instead of taking the money from those sales and passing it on to you, they simply kept the money, according to the suit.

How wormy were those apples? In one infamous email cited in the suit, a Bear exec colorfully described the content of the bonds they were selling:

Bear deal manager Nicolas Smith wrote an e-mail on August 11th, 2006 to Keith Lind, a Managing Director on the trading desk, referring to a particular bond, SACO 2006-8, as "SACK OF SHIT [2006-]8" and said, "I hope your [sic] making a lot of money off this trade."

So did Verschleiser himself know the mortgages were bad? Not only did he know it, he went so far as to tell his colleagues in writing that it was a waste of money to even bother performing due diligence on the bad bonds:

Jeffrey Verschleiser even said in an e-mail that he knew this was an issue. He wrote to his peer Mike Nierenberg in March 2006, "[we] are wasting way too much money on Bad Due Diligence." Yet a year later nothing had changed. In March 2007, Verschleiser wrote to Nierenberg again about the same due diligence firm, "[w]e are just burning money hiring them."


One of the ways that banks like Bear managed to convince investors to buy these bonds was by wrapping them in bond insurance through companies like Ambac, commonly known as “monoline” insurers. Investors who knew the bonds were insured were less worried about default.

Read more: Everything You Need to Know About Wall Street, in One Brief Tale | Matt Taibbi | Rolling Stone


~S~

 

[editec]

No GOLD STANDARD is going to prevent corrupt officials from diluting the money supply.

the ONLY way a GOLD STANDARD would work to prevent that would be if we weren't on a gold standard for money, we'd have to eliminate paper money ENTIRELY.

And that system has its own problems. Problems that can be worse than what we're facing right now.

Then the growth of the economy has to directly equal the amount of NEW gold that is found.

If more gold is found that the the growth of the GNP, we're have inflation.

If less gold is found than the gowth of the GNP, we'd have DEflation.

 

[samjones]

What do you mean unreasonable? The price of homes is determined by the supply of and demand for houses. One thing affecting the current demand for houses is their expected future price. If people expect the price of houses to be permanently higher next year, they'll want to buy this year. If people expect that in three years the price of housing will fall back to its trend level, nobody will enter into a contract where they're paying more over the next 20 years for a house than what it'll be worth. There was so much demand for housing because home prices were expected to be high permanently. Do you have some mechanism through which mark-to-market managed to trick people into believing that house prices would be persistently high?

Wait, do you seriously expect me to believe that the bubble was simply a function of supply and demand, as if the supply of housing had suddenly precipitously dropped, perhaps because of some enormous natural disaster, or the demand for housing suddenly increased enormously, perhaps because someone discovered gold?

That makes no sense.

Do you seriously expect me to buy irrational exuberance and a belief that the values are going to keep going up up and up? These are houses, not .coms.


It's not nice, what the investment banks did with repackaging these bad loans and hiding their volatility and that may be a problem of its own, but it doesn't change the fact that these were bad loans. We keep blaming the symptoms and not looking at the root cause.

Which is that the banks overvalued the homes that they were lending on because of mark-to-market accounting. They're the ones who should have known better. They would have in the previous decade.

 

[samjones]

One of the ways that banks like Bear managed to convince investors to buy these bonds was by wrapping them in bond insurance through companies like Ambac, commonly known as “monoline” insurers. Investors who knew the bonds were insured were less worried about default.[/FONT][/SIZE]

It's like blaming the Kleenex for the cold. Ultimately it's the government's responsibility to keep bad money out of the system. If they don't then disreputable firms or disreputable people and otherwise reputable firms will get their mitts on it.

Bear wasn't responsible for the culture of bad home loans.

 

[DSGE]

What do you mean unreasonable? The price of homes is determined by the supply of and demand for houses. One thing affecting the current demand for houses is their expected future price. If people expect the price of houses to be permanently higher next year, they'll want to buy this year. If people expect that in three years the price of housing will fall back to its trend level, nobody will enter into a contract where they're paying more over the next 20 years for a house than what it'll be worth. There was so much demand for housing because home prices were expected to be high permanently. Do you have some mechanism through which mark-to-market managed to trick people into believing that house prices would be persistently high?

Wait, do you seriously expect me to believe that the bubble was simply a function of supply and demand, as if the supply of housing had suddenly precipitously dropped, perhaps because of some enormous natural disaster, or the demand for housing suddenly increased enormously, perhaps because someone discovered gold?

That makes no sense.

Do you seriously expect me to buy irrational exuberance and a belief that the values are going to keep going up up and up? These are houses, not .coms.


It's not nice, what the investment banks did with repackaging these bad loans and hiding their volatility and that may be a problem of its own, but it doesn't change the fact that these were bad loans. We keep blaming the symptoms and not looking at the root cause.

Which is that the banks overvalued the homes that they were lending on because of mark-to-market accounting. They're the ones who should have known better. They would have in the previous decade.

You still haven't actually explained the mechanism through which mark to market increases home prices. Mark to market means that for an object you hold on your balance sheet the value of that object is determined by the current prevailing market price. I'm guessing you're trying to say that this inflated the asset side of balance sheets and allowed them to engage in more lending. Except banks didn't hold sub-prime mortgages on their balance sheets. They quickly securitized them off their balance sheets. So how does mark to market have any effect?

 

[samjones]

I'm guessing you're trying to say that this inflated the asset side of balance sheets and allowed them to engage in more lending. Except banks didn't hold sub-prime mortgages on their balance sheets. They quickly securitized them off their balance sheets. So how does mark to market have any effect?

Yes and no. Sub-primes were certainly a victim of the housing bubble and the way that investment banks packaged and misrepresented the value of subprime loans certainly caused a financial crisis, but all of this serves only to distract from the root cause analysis.

What caused the housing bubble? (Certainly you agree that the housing bubble affected all types of real estate, not only poor people and not only subprime loans).

I believe that ultimately banks simply overstated the value of the homes that they loaned money for. If historical accounting methods had been used the problem would not have been this severe and the same historical method that reduced the severity would have healed the damaged market.

 

[EdwardBaiamonte]

Except banks didn't hold sub-prime mortgages on their balance sheets. They quickly securitized them off their balance sheets. So how does mark to market have any effect?

1) mark to market was a huge huge problem. When the housing market collapsed the market value of homes was way down which meant the banks in effect held no collateral for the loans they made many of which were held on their books and not sold off. This meant they had to raise capital to meet capital requirements or in effect declare bankruptcy.

2) Interstingly, mark to market became important in the wake of the Enron scandal wherein Enron had played fast and loose with imagined market values. In sum, the housing crisis was in part brought on by new liberal regulations arising from the Enron scandal. This is why when a liberal talks about "well regulated capitalism" you want to shoot him. It is naive beyond belief.

3) Most importantly, the liberal policy was to inflate or bubble up the housing market with low interest rates so this must be seem as the heart of the liberal crisis. Left and right agree!!

CATO: "First consider the once controversial view that the crisis was largely caused by the Fed's holding interest rates too low for too long after the 2001 recession. This view is now so widely held that the editorial pages of both the NY Times and the Wall Street Journal agree on its validity!"...John B. Taylor( arch conservative, author of the Taylor Rule)


" The Federal reserve having done so much to create the problems in which the economy is now mired, having mistakenly thought that even after the housing bubble burst the problems were contained, and having underestimated the severity of the crisis, now wants to make a contribution to preventing the economy from sinking into a Japanese Style malaise....... - "Joseph Stiglitz"


You may not have heard of the Federal Reserve system but it exists to inflate and deflate the currency supply through the housing market. They inflated too much for too long. This caused what they call a housing bubble. While the bubble was inflating all the big banks and many insurance companies bought bubble mortgages thinking they were sound rather than merely purchased or made possible by newly printed funny money. When the bubble deflated they all lost money on the mortgages. It would be analogous to the government making cars and giving them to GM so everyone could have a car. If GM got them by the ton and for very little money of course they would find a way to move them . This is essentially what the Banks did with the free money. In addition to the Federal Reserve System you had Fanny and Freddie which bought and guaranteed many of the mortgages so no one had to worry about them failing.

 

[samjones]

CATO: "First consider the once controversial view that the crisis was largely caused by the Fed's holding interest rates too low for too long after the 2001 recession. This view is now so widely held that the editorial pages of both the NY Times and the Wall Street Journal agree on its validity!"...John B. Taylor( arch conservative, author of the Taylor Rule)

There's something to this. I agree with this statement. The NY Times and WSJ have both argued pretty consistently that easy money caused the housing bubble. The editorial staff at both papers clearly have a good grasp of economic policy, but they may not have such a strong grasp of the concepts associated with "root cause analysis" and therefore they can have a correct understanding of the facts and still not have a good understanding of how to present them in a way that constructively explains what happened and how it can be prevented in the future.

1. Easy money is part of America's banking system. It's an inherent risk.
2. The Fed primarily looks for inflationary pressures when determining whether to raise interest rates. No inflation, they stay low. Pre-2008 I don't know how Greenspan would have conveyed the message to us that inflation was low but he was going to hike rates because our houses were fetching too much on the market. I don't think many of us would have understood that rationale.

Bottom-line, blaming the Housing Bubble on low interest rates is like blaming an electrical fire on electricity. Blaming the fed for not preventing it is like blaiming the power company for continuing to supply your home with power.

In a proper root-cause analysis you would examine the changes that happened and when they happened so that you could determine how actions that may have seemed benign could have triggered disastrous consequences. On, in other words, you'd look into the work that was done by the electrician that came in the week before.

That takes us back to mark-to-market accounting.

 

[editec]

I only have one significant point to add to this discussion as it regards the insane increaes in housing prices.

What fueled those increases was the ready availability of money to buy homes.

When there was more money to borrow, that drove up demand, thus naturally driving up prices.

Then round two comes along and real estate appraisers (who report on MARKET VALUES) had no choice but to find that their COMPS had higher prices.

THUS banks (who no longer held the paper on these outstanding loans and who enticed people into buying more than they could afford with low interest variable rate loans) were willing to lend more money for inflating home purchases.

This REAL ESTATE inflationary cycle continued like that for a couple decades.

But finally the music of the WHO ENDS UP WITH THE BAD DEBT? game ended.

Interest rates for homes rose when their VARIABLE rates kicked in.

Suddently people who'd just bearly been paying for those homes could no longer pay those new rates or borrow at higher rates, the new home buyer RE market began to contract, the number of homes going on the market increased as homes were reposessed, and, coupled with the disasterous effects of the DERIVATIVES gambles, that banksters DISCOVERED they'd screwed THEMSELVES WITH, the whole teetering house of financial cards that DEBT build began to collapse.

There is no SINGLE villian in this story.

There are a combination of events and policys and cynical players (too) that lead to the RE market inflation AND contraction that followed.

BOTH political parties played their roles in setting up these conditions, and the BANSTERS told them EXACTLY what they knew the POLS wanted to hear to GET them to be such GOD DAMNED FOOLS, too.

 

[samjones]

I only have one significant point to add to this discussion as it regards the insane increaes in housing prices.

What fueled those increases was the ready availability of money to buy homes.

Yeah but the WSJ and the NY Times actually agreed on something, and that was it. And Ed and I actually agreed on something and that was it. "Fueled' and "caused" are 2 different things.

Easy money to buy a home is as American as mom and apple pie. It will never stop and that makes me happy. Americans should buy their own homes. It's what makes us tick.

Easy money is important to borrower and lender alike - that means both the little guy and the big guy need for the American Dream to be amortized over 30 years.

The lament of our generation is that we didn't buy earlier.

 

[EdwardBaiamonte]

"First consider the once controversial view that the crisis was largely caused by the Fed's holding interest rates too low for too long after the 2001 recession. This view is now so widely held that the editorial pages of both the NY Times and the Wall Street Journal agree on its validity!"...John B. Taylor( arch conservative, author of the Taylor Rule)

There's something to this. I agree with this statement. The NY Times and WSJ have both argued pretty consistently that easy money caused the housing bubble. The editorial staff at both papers clearly have a good grasp of economic policy, but they may not have such a strong grasp of the concepts associated with "root cause analysis"

of course thats idiotic since Taylor and Stieglitz are 2 of the greatest living economists who do nothing but think about root causes!!!!!



[

 

[EdwardBaiamonte]

Easy money to buy a home is as American as mom and apple pie. It will never stop and that makes me happy.

absurd, The Fed mandate is stable prices, not easy money and recessions!! Econ 101

 

[samjones]

of course thats idiotic since Taylor and Stieglitz are 2 of the greatest living economists who do nothing but think about root causes!!!!!

Fair enough.... I guess you hold Paul Krugman and Larry Summers in equally high esteem?

I'm not interested in arguing with Taylor or Stiglitz's analysis. Clearly they have better economic minds than I, which accounts for the reason I'm bantering with you.

What I will say is that neither of the quotes that you provided show either of them establishing low interest rates as the *root* cause. There's a difference. Back to my analogy, a slow fire department response may be the cause of your house burning down, but it isn't the *root* cause. The root cause is whatever started the fire.

What I will also say is that it's easy for the Times of the Journal to point a finger at the Fed and say "you kept interest rates too low for too long" because they do not carry the burden of expertise. An expert (like Taylor or Stiglitz) would have to provide actual evidence that this was the case and then advice about what should have been done and why. In other words, they would point out what economic indicators in the future should prompt the Fed to raise interest rates based on the facts we know from the '08 crisis.

 

[DSGE]

of course thats idiotic since Taylor and Stieglitz are 2 of the greatest living economists who do nothing but think about root causes!!!!!

What I will also say is that it's easy for the Times of the Journal to point a finger at the Fed and say "you kept interest rates too low for too long" because they do not carry the burden of expertise. An expert (like Taylor or Stiglitz) would have to provide actual evidence that this was the case and then advice about what should have been done and why. In other words, they would point out what economic indicators in the future should prompt the Fed to raise interest rates based on the facts we know from the '08 crisis.

In Taylor's case, his complaint is that the Fed kept the interest rate lower than what the Taylor Rule prescribes; a rule John Taylor just made up.

 

[EdwardBaiamonte]

of course thats idiotic since Taylor and Stieglitz are 2 of the greatest living economists who do nothing but think about root causes!!!!!

What I will also say is that it's easy for the Times of the Journal to point a finger at the Fed and say "you kept interest rates too low for too long" because they do not carry the burden of expertise. An expert (like Taylor or Stiglitz) would have to provide actual evidence that this was the case and then advice about what should have been done and why. In other words, they would point out what economic indicators in the future should prompt the Fed to raise interest rates based on the facts we know from the '08 crisis.

In Taylor's case, his complaint is that the Fed kept the interest rate lower than what the Taylor Rule prescribes; a rule John Taylor just made up.

Wiki: Although the Federal Reserve does not explicitly follow the Taylor rule, many analysts have argued that the rule provides a fairly accurate summary of US monetary policy under Paul Volcker and Alan Greenspan.[7][8] Similar observations have been made about central banks in other developed economies, both in countries like Canada and New Zealand that have officially adopted inflation targeting rules, and in others like Germany where the Bundesbank's policy did not officially target the inflation rate.[9][10] This observation has been cited by Clarida, Galí, and Gertler[7] as a reason why inflation had remained under control and the economy had been relatively stable (the so-called 'Great Moderation') in most developed countries from the 1980s through the 2000s. However, according to Taylor, the rule was not followed in part of the 2000s, possibly leading to the housing bubble.[11][12]

 

[DSGE]

What I will also say is that it's easy for the Times of the Journal to point a finger at the Fed and say "you kept interest rates too low for too long" because they do not carry the burden of expertise. An expert (like Taylor or Stiglitz) would have to provide actual evidence that this was the case and then advice about what should have been done and why. In other words, they would point out what economic indicators in the future should prompt the Fed to raise interest rates based on the facts we know from the '08 crisis.

In Taylor's case, his complaint is that the Fed kept the interest rate lower than what the Taylor Rule prescribes; a rule John Taylor just made up.

Wiki: Although the Federal Reserve does not explicitly follow the Taylor rule, many analysts have argued that the rule provides a fairly accurate summary of US monetary policy under Paul Volcker and Alan Greenspan.[7][8] Similar observations have been made about central banks in other developed economies, both in countries like Canada and New Zealand that have officially adopted inflation targeting rules, and in others like Germany where the Bundesbank's policy did not officially target the inflation rate.[9][10] This observation has been cited by Clarida, Galí, and Gertler[7] as a reason why inflation had remained under control and the economy had been relatively stable (the so-called 'Great Moderation') in most developed countries from the 1980s through the 2000s. However, according to Taylor, the rule was not followed in part of the 2000s, possibly leading to the housing bubble.[11][12]

How do you think this is an insightful or interesting thing to post? Do you even know what a Taylor rule is?

 

[samjones]

However, according to Taylor, the rule was not followed in part of the 2000s, possibly leading to the housing bubble.[11][12]

I'm not convinced. I read the cited PDF. I agree that Taylor has established correlation and I agree that easy money could have exacerbated the bubble problem. It certainly contributed to the subprime crisis - but hopefully by now the combatants still standing in this cage war all agree that the subprime crisis and the housing bubble are 2 separate things.

*IF* you bouight in 2006 and *IF* you bought a house you can afford and *IF* you bought in stable reliable neighborhood and *IF* you borrowed on favorable terms with a fixed rate mortagage and +20% down..... even *IF* you did all that your house is still likely to be selling for one number less on the left side than you bought it for.

This is hard on the banks because it affects their lending pool and makes them less able to fulfill their mission of fnancier. This paralyzes the housing market in general. This is the primary cause of the financial crisis of '08. I have to ask myself why banks were so willing to delude themselve into believing that the house they were lending on were worth the money they were lending....

In the Sam Jones analysis - that is the path to finding root cause.