by hilzoy
I'm late getting to John McCain's speech on the housing crisis, in which he promised to do next to nothing to help homeowners, to convene a meeting of accountants, to cut taxes, and, in a surprising break with most economists here on planet earth, to respond to the present financial problems by cutting regulation [UPDATE: as von notes, this is McCain's response to what he calls "an explosion of complex financial instruments that weren't particularly well understood by even the most sophisticated banks, lenders and hedge funds" As von correctly notes, McCain does propose new regulation on mortgage lenders. END UPDATE.] The idea that overregulation is at the heart of our present predicament might seem counterintuitive. But the fact that McCain believes it is a lot easier to understand when you realize that his chief economic advisor and general campaign co-chair is Phil Gramm, who seems never to have met a financial regulation he didn't want to destroy.
Gramm, who has been described as "McCain's econ brain" and "the expert he turns to on the subject," didn't just oppose financial regulations in general. He helped to create the conditions for the mortgage crisis, and others, in quite specific ways. Lisa Lerer at Politico has more:
"The general co-chairman of John McCain’s presidential campaign, former Sen. Phil Gramm (R-Texas), led the charge in 1999 to repeal a Depression-era banking regulation law that Democrat Barack Obama claimed on Thursday contributed significantly to today’s economic turmoil. (...)A year after the Gramm-Leach-Bliley Act repealed the old regulations, Swiss Bank UBS gobbled up brokerage house Paine Weber. Two years later, Gramm settled in as a vice chairman of UBS’s new investment banking arm.
Later, he became a major player in its government affairs operation. According to federal lobbying disclosure records, Gramm lobbied Congress, the Federal Reserve and Treasury Department about banking and mortgage issues in 2005 and 2006.
During those years, the mortgage industry pressed Congress to roll back strong state rules that sought to stem the rise of predatory tactics used by lenders and brokers to place homeowners in high-cost mortgages.
For his work, Gramm and two other lobbyists collected $750,000 in fees from UBS’s American subsidiary. In the past year, UBS has written down more then $18 billion in exposure to subprime loans and other risky securities and is considering cutting as many as 8,000 jobs."
The 1999 bill that Gramm sponsored overturned the Glass-Steagall Act, which (among other things) separated investment banks from ordinary banks. Gramm's bill was an enormously important piece of financial legislation, and by allowing banks and brokerages to merge, it set in place some of the conditions that hampered scrutiny of mortgage-backed securities, and made the damage from the present meltdown harder to contain. As Paul Krugman wrote last week:
"I’d argue that aside from Alan Greenspan, nobody did as much as Mr. Gramm to make this crisis possible."
Isn't that comforting?
But Gramm isn't just involved in this economic meltdown...
He and his wife had important roles in the Enron collapse as well:
"Mr. Gramm, a Texas Republican, is one of the top recipients of Enron largess in the Senate. And he is a demon for deregulation. In December 2000 Mr. Gramm was one of the ringleaders who engineered the stealthlike approval of a bill that exempted energy commodity trading from government regulation and public disclosure. It was a gift tied with a bright ribbon for Enron.Wendy Gramm has been influential in her own right. She, too, is a demon for deregulation. She headed the presidential Task Force on Regulatory Relief in the Reagan administration. And she was chairwoman of the U.S. Commodity Futures Trading Commission from 1988 until 1993.
In her final days with the commission she helped push through a ruling that exempted many energy futures contracts from regulation, a move that had been sought by Enron. Five weeks later, after resigning from the commission, Wendy Gramm was appointed to Enron's board of directors.
According to a report by Public Citizen, a watchdog group in Washington, ''Enron paid her between $915,000 and $1.85 million in salary, attendance fees, stock options and dividends from 1993 to 2001.''
As a board member, Ms. Gramm has served on Enron's audit committee, but her eyesight wasn't any better than that of the folks at Arthur Andersen. The one thing Enron did not pay big bucks for was vigilance."
And:
"In June 2000, Senator Gramm co-sponsored the Commodity Futures Modernization Act, a measure aimed at deregulating certain kinds of futures trading, but not energy futures. That bill never made it to the floor, and thus quietly died. Six months later, on December 15, Gramm curiously turned up as co-sponsor of a bill with the same name, the Commodity Futures Modernization Act, which did deregulate energy futures and which, without undergoing the usual committee hearings and preliminary votes, was immediately attached as a rider to an 11,000-page appropriations bill. It passed and was signed into law by President Bill Clinton six days later. Few lawmakers had likely perused the rider carefully, if they even knew it was there. And at any rate, Enron had given to the campaigns of over 200 legislators.That's not to say no one opposed Enron's aims. An economics advisory group to Clinton—with representatives from the Federal Reserve, SEC, and Commodity Futures Trading Commission—had come out against deregulated energy trading. They argued the market was ripe for manipulation. Yet the bill passed, setting Enron free to run what amounted to an energy auction, which Public Citizen claims "gained control over a significant share of California's electricity and natural gas market."
All during this period there was a series of remarkable coincidences. Between June and December 2000, the California energy situation was worsening but still not in crisis. After the Gramm bill went through, all hell broke loose, with one emergency rolling blackout after another. There were charges that out-of-state suppliers were withholding gas and running up the price. Finally, in June 2001, public pressure forced the Federal Energy Regulatory Commission, or FERC, to reassert price controls."
In the aftermath of Enron's collapse, Wendy Gramm was named in a number of lawsuits against the company, at least one of which was settled on terms that required her to pay part of the settlement from her personal assets. Did the collapse of Enron make Gramm rethink his views on financial regulation in any way? Apparently not:
"Republicans led by Senator Phil Gramm of Texas and the accounting industry's trade group are working to kill a Democratic measure that would impose new rules on auditors, companies and investment banks in the wake of Enron's collapse.The bill was drafted by Senator Paul S. Sarbanes, Democrat of Maryland and the chairman of the Senate Banking Committee, and is scheduled to be considered on Tuesday by Mr. Sarbanes's panel. It was endorsed today by a group that included Paul A. Volcker, the former chairman of the Federal Reserve.
But Congressional officials said today that Republicans, led by Mr. Gramm, were preparing to use parliamentary maneuvers to delay the measure and either water it down or have it killed."
[UPDATE: See footnote at end.]
Phil Gramm was also a hypocrite:
"Mr. Gramm should be remembered for perfecting one of the more duplicitous roles in politics -- the anti-government welfare queen. He has run his every campaign as a scourge of government spending and a champion of the beleaguered little taxpayer. At the same time he has built a great money sluice from Washington to his home state and pandered to the energy, banking and insurance lobbies that underwrite his political ambitions. His politics could be called hypocrisy, but only in a language that places a huge premium on understatement.Contrast Mr. Gramm with Representative Dick Armey, another Texan with a mean streak, a Ph.D. in economics and a professed distaste for government spending. Mr. Armey, who is also retiring after this Congress, had the intellectual integrity to fight federal farm subsidies and to engineer the closing of unneeded military bases, including one serving his home district. Not so Mr. Gramm, who once boasted, ''I'm carrying so much pork, I'm beginning to get trichinosis.''"
***
While I was researching this, I realized that Gramm is one of those politicians who is both quotable himself and attracts marvelous quotes to him. (In both cases, the driving force seems to be his meanness.) Herewith, some examples:
"Two favorite Gramm jokes.1)"People say I don't have a heart. I do. I keep it in a quart jar on my desk."
2) Gramm claimed he was so popular among a certain group of voters that they offered "to buy me an artificial heart." Gramm said he refused, telling them, "I'm doing fine without one.""
PBS:
"In a recent interview with The New York Times, Mrs. Gramm recalled her initial response to his subsequent marriage proposal: "Yuck.""
"Before you feel a jot of sympathy for Gramm, however, recall that he is the kind soul who once wrote to a vanquished opponent. "I feel so sorry for your many problems, but you deserve them.""
And then there's the late and much lamented Molly Ivins, who is, as usual, so wonderful that I have to quote her at length:
"Hail and farewell to two of the meanest guys ever to serve in the U.S. Congress -- Senator Phil Gramm and House Majority Leader Dick Armey, both from Texas. What a barrel of knee-slapping fun they have been. As each winds up his final year in office, we could have a fine time recalling their Meanest Moments: The side-splitting occasion when Armey referred to Rep. Barney Frank of Massachusetts as "Barney Fag." The rib-tickling time Gramm wanted to deny food stamps to elderly legal immigrants on the splendid grounds that extending aid would only foster dependency, thereby inflicting "a new personal tragedy on the most vulnerable among us." (...)Gramm both looks like a snapping turtle and has the personality of one. When he ran for president in 1996 and finished fifth in Iowa, all the profiles written of him included the line "Even his friends don't like him." Self-righteous and strident, Gramm demonized his opponents and used bitter, polarizing rhetoric. During a Senate debate over Social Security, a member pointed out that the proposal under consideration would hurt 80-year-old retirees. "Most people don't have the luxury of living to be 80 years old," Gramm scoffed, "so it's hard for me to feel sorry for them." Well, there is that.
On another occasion, Gramm ridiculed a newspaper photo of poor people who were forced to cut corners to put food on the table. "Did you see the picture?" Gramm asked a crowd. "Here are these people who are skimping to avoid hunger and they are all fat!... We're the only nation in the world where all our poor people are fat." During the fight over health care reform, Gramm said, "We have to blow up this train and the rails and the trestle and kill everyone on board." When an elderly widow in Corsicana told him that cutting Medicare would make it more difficult for her to remain independent, Gramm said, "You haven't thought about a new husband, have you"
When he first ran for Senate in 1984, Gramm's main attack ad focused on how his opponent, a young state senator, had received a check for $600 raised by a gay group at a male strip joint in San Antonio. He had not solicited the contribution and promptly returned it, but Gramm ran lurid ads about the gay strip show for months.
His tactics have not won him any friends among Texas politicians. Gramm is notorious for letting Texas congressmen do all the work of getting federal projects in their districts and then stepping up to claim credit when the project is approved. The noun for this is "Grammstanding," and it is now part of the political lexicon.
Gramm, the great crusader against government spending, has spent his entire life on the government tit. He was born at a military hospital, raised on his father's Army pay, went to private school at Georgia Military Academy on military insurance after his father died, paid for his college tuition with same, got a National Defense Fellowship to graduate school, taught at a state-supported school, and made generous use of his Senate expense account. In 1987, a Dallas developer named Jerry Stiles flew a construction crew to Maryland to work on Gramm's summer home. Stiles spent $117,000 on the project but was kind enough to bill Gramm only $63,433. When Stiles got in trouble for misusing funds from a savings and loan he owned, Gramm did him some "routine" favors with regulators. Stiles was later convicted on 11 counts of conspiracy and bribery.
As a member of the Senate Finance Committee and the recipient of enormous banking contributions, Gramm did an even bigger favor for the financial industry in 1999 when he sponsored the Financial Services Modernization Act allowing banks, securities firms, and insurance companies to combine. The bill weakened the Community Reinvestment Act, which requires banks to help meet the credit needs of low- and moderate-income neighborhoods. Gramm described community groups that use the CRA as "protection rackets" that extort funds from the poor, powerless banks. The bill is also a disaster for the privacy of bank customers and weakens regulatory supervision. As Gramm proudly declared, "You're not going to find a single bank, insurance company, or securities company that will say they were hurt financially by this bill.""
John McCain's chief economic advisor and campaign co-chair. What a delightful thought.
If you liked Herbert Hoover, you'll love Gramm and McCain.
***
UPDATE: Footnote on Gramm and Sarbanes-Oxley: In response to this quote:
"Republicans led by Senator Phil Gramm of Texas and the accounting industry's trade group are working to kill a Democratic measure that would impose new rules on auditors, companies and investment banks in the wake of Enron's collapse."
In comments, JayS noted that this measure became Sarbanes-Oxley, and that Phil Gramm voted for it. This is true: Sarbanes-Oxley passed the Senate 99-0, and became law; and Phil Gramm was one of the 99 Senators who voted for it.
I hadn't remembered that Gramm voted for the bill, so I went back to check. I'd summarize what I found as follows: Gramm tried to defeat S-O, but in the end the various scandals that kept exploding made it impossible for him to vote against it. (Though he did vote against it in committee.) In any case, here's some history, so you can judge for yourselves rather than taking my word for it. On May 18, 2002, the article I cited said that Gramm was working to defeat what would become Sarbanes-Oxley. On May 21:
"Facing enormous opposition from the financial services industry and some Republican lawmakers, the chairman of the Senate Banking Committee postponed a meeting scheduled for Tuesday at which lawmakers would have considered an overhaul of accounting industry regulations inspired by the collapse of Enron.House Republicans have already passed an accounting bill that is favored by the accounting industry and business groups, but Senator Paul S. Sarbanes, Democrat of Maryland and the committee chairman, has proposed a competing bill that would go further in tightening oversight of the industry.
His bill is supported by consumer groups and institutional investors, as well as some leading figures in finance.
Republicans, led by Senator Phil Gramm of Texas, had sought to delay consideration of Mr. Sarbanes' bill, and they have flooded the committee with proposed amendments."
On June 19, 2002:
"Overcoming fierce lobbying by the accounting industry, the Senate Banking Committee approved legislation today that would ban accounting firms from selling many forms of consulting services to their audit clients, limit the time an individual partner could review one company's books and create a regulatory board made up mostly of people outside the industry. (...)Three days after the guilty verdict in the obstruction of justice trial of the accounting firm Arthur Andersen, the committee passed the bill, with 6 Republicans and all 11 Democrats voting for it. Four Republicans voted no: Rick Santorum of Pennsylvania, Michael D. Crapo of Idaho, John Ensign of Nevada and the former committee chairman, Phil Gramm of Texas, who had led efforts to defeat the measure." (Emphasis added.)
"In the clearest sign thus far that Republican Congressional leaders are moving far beyond the White House in supporting stiff penalties for corporate wrongdoing, House Speaker J. Dennis Hastert endorsed a Senate proposal today that called for tough new criminal sanctions and expanded prison terms.One after another, lawmakers in both parties seemed intent on one-upping one another.
''In the environment we are in, virtually anything can pass,'' Senator Phil Gramm of Texas told reporters tonight after a dizzying day of legislative maneuvering over new measures to address corporate malfeasance. ''Everybody is trying to outdo everybody else.'' (...)
Mr. Gramm, who is closer to the president, made it clear today that he supported the Democratic-backed Senate proposals on criminal penalties. But Mr. Gramm said he still hoped to drastically scale back broad Democratic proposals for accounting and corporate-governance reforms."
"House and Senate negotiators agreed today on a broad overhaul of corporate fraud, accounting and securities laws aimed at curbing the rampant abuses that have shaken Wall Street. Final approval in Congress is expected within days, and President Bush has said he will sign the bill into law. (...)The legislation has enjoyed extraordinary momentum in the last three weeks, but its outlook had been cloudy until mid-June. While Mr. Sarbanes had managed to get the bill out of his committee on a bipartisan vote, lobbyists and some leading Republicans had pledged to rewrite it when it got to conference committee.
That changed, however, as the scandals at Tyco, Adelphia and WorldCom, and the perception that the fall in the stock market stemmed from a loss of investor confidence, made it increasingly risky for any politician to object to the measure.
Last week, President Bush undercut efforts by some Republicans to modify the legislation by demanding a final bill before Congress departs Washington for the August recess.
''When you are working under those circumstances, it's hard to work out the practical details that often need to be worked out, so that a couple of years from now you end up saying, 'You know, this has worked pretty well,' '' Senator Phil Gramm, Republican of Texas and the chief critic of Mr. Sarbanes's bill, said this afternoon.
''The focus of these kinds of debates is more on the sort of rhetoric and media response than it is on practicality,'' Mr. Gramm said. ''That's just the very nature of the process when you've got a crisis atmosphere.''
Tonight, at the conference meeting, Mr. Gramm added that he feared that the bill ''will do more harm than it should,'' citing what he said were provisions that would encourage ''predatory'' lawsuits and other language that he said would prove onerous for thousands of smaller publicly traded corporations."
Anytime you want to know about a Texas politician, just see what Molly Ivins had to say about them. What a terrific woman.
Posted by: Andrew | March 30, 2008 at 01:15 PM
My sentiment: (Bruce Cockburn).
Monumentally SLIMY. Yuck ain’t the half of it.
That John’s got some kinda judgment. eh? If I ever, ever had any doubts; not never no more.
Trichinosis of the brain, soul and spirit. Call in the maggots.
Posted by: felix culpa | March 30, 2008 at 02:08 PM
Depressing. I mean its all kind stuff I knew, but when you lay it out this way it has a lot more impact. Blah.
Posted by: OCSteve | March 30, 2008 at 02:19 PM
Posted by: jpe | March 30, 2008 at 02:24 PM
Gramm sounds mean, but he really isn’t. Bono sounds ethical, but he really isn’t.
I can’t find a historic parallel for the times in which we are living. Slavery was accepted as normal in the Bible, Greece, Rome, Qur’an, and early America. Things were probably far worse in the dark and middle ages. Maybe the closest parallel is Rome-212AD, when Caracalla granted Roman Citizenship to all non-slaves, who promptly rioted (then came the Germans).
http://www.roman-emperors.org/caracala.htm
The wave of wealth that has enabled what we see was the result of what this pure democracy had inherited, has subsequently spent, and still borrows against to the tune of $200,000 per newborn. People are still lending us money, not with the expectation of collecting in thirty years, but with the expectation of being able to dump the IOUs before the next guy figures things out.
Dependence is historically a precursor to slavery. Gramm’s efforts countered dependence. Bono’s efforts will result in a larger number of people starving to death. Bono is the bigger ass.
Posted by: Brick Oven Bill | March 30, 2008 at 02:26 PM
jpe: it makes him a scourge of government spending, except when the money is spent in his state. Since when is someone who opposes wasteful spending and also says ''I'm carrying so much pork, I'm beginning to get trichinosis'' not a hypocrite?
I mean: it would be one thing to oppose wasteful spending, but still have some earmarks, on the grounds that if that's how spending is divvied up, so be it. It's another to brag about how much pork you are bringing home.
Posted by: hilzoy | March 30, 2008 at 02:35 PM
I missed the pork bit, evidently. I'm a lousy skimmer.
Posted by: jpe | March 30, 2008 at 02:37 PM
Great job, Hilzoy.
Phil Gramm (and sweet Wendy) are the predatory heart of the modern Republican Party.
That they again come close to the center of governance, particularly at this time of financial decadence, is testimony to the ability of the American people to be thrown off the scent of real corruption by prostitution scandals, loud-mouthed but powerless religious leaders, and some stupid lies about running across the airport tarmac under fire.
Gramm is a hypocrite like a shark (apologies to sharks) is a hypocrite -- all of it is prey, whether it tastes good or not.
One quibble: Gramm is not like Hoover, or McCain for that matter. Hoover's inattention to what happened in 1929-1932 was a touching, naive trust in a particular ideology. McCain, for all the good will he gained in his five years as a POW, may have survived that ordeal by being too stupid not to survive.
Gramm is all fist, jackboot, and surly mouth. It's not good enough that his enemies are prostrate before him; his real joy is administering the kick in the short-ribs and the gob of spit in the face.
That none of his public appearances have ended in violence is testimony to the big collective heart of the American people, a purely lucky advantage the heartless have always had in this great country of ours.
His ilk made a big deal about owning a gun as a defense against government. If Gramm touches my government again, two guns might not be enough.
Posted by: John Thullen | March 30, 2008 at 03:34 PM
While I enjoy bashing Phil Gramm, the reference to opposition to the regulatory bill in 2002 needs a little addendum. The May 18,2002 article appears to be referencing Sarbanes-Oxley. That bill passed in the Senate July 25,2002 99-0 with Gramm voting for it.
Posted by: JayS | March 30, 2008 at 04:01 PM
JayS: thanks, I had forgotten that he voted for S-O. I updated with a bunch of background (at the end of the post.)
Posted by: hilzoy | March 30, 2008 at 05:20 PM
Thank you Hilzoy. I had been trying to find contemporaneous accounts of S-O to understand why and when he changed his position without much luck.
Carry on.
Posted by: JayS | March 30, 2008 at 06:05 PM
JayS: I love the NYT search engine and open archives. One little search on "Gramm Sarbanes", and the heavens opened. ;)
Posted by: hilzoy | March 30, 2008 at 06:35 PM
Brick boy, buddy, ya got it a little confused there. Gramm’s efforts forced us towards dependence. Without his deregulation and his passion for hogsheads of fraudulent pork we’d be less dependent on foreign funds.
Your point on the dumping of IOU’s is well taken though. The question has been raised about whether the sovereign funds will continue to think us worth their while if things haven’t shown signs of change a year from now.
Certainly our wealth is no longer our own, and we are no longer masters of the universe thanks in significant part to everything McCain and Gramm stand for unashamedly.
And also yes, Rome’s last days are what I thought of when you raised the question. Soft as pork fat we are, and just as stupefied by wealth and power. The citizenry, on the other hand may turn around and choose less corrupt leadership who may be able to pull the fat out of the fire.
Posted by: felix culpa | March 30, 2008 at 08:41 PM
I really hate to say anything but your posts are getting to be consistently very long by blog standards.
Posted by: Frank | March 30, 2008 at 08:52 PM
Wow, Hilzoy. I thought that the topic of this post was McCain's (allegedly) terrible speech on the collapse of the housing market. Instead, it's an extended ad hominem against Phil Gramm. Gramm may very will deserve the abuse. Perhaps McCain shouldn't be listening to him. And maybe voters should take Phil Gramm into account when weighing their votes for (or against) McCain. But Phil Gramm has nothing to do with the points that McCain made in his speech.
That aside, you've grossly mischaracterized McCain's speech. You write:
All four points are misleading -- or at most only half-correct -- but the final one is wrong and offensive. You wrote that "in a surprising break with most economists here on planet earth, [McCain promised] to respond to the present financial problems by cutting regulation."
Here's what McCain actually said:
All of that is f_cking new regulation. All. Of. It. Did you not read it? Not understand it? Expect your readers not to read or understand it?
As for the one -- one! -- area that McCain proposed to deregulate, here it is:
Now, this may be a good idea or it may be a bad idea, but certainly it shouldn't be beyond the pale to ask this narrow question about whether certain regulations may be to blame for a small part of the housing collapse.. And certainly McCain doesn't deserve your sarcasm when no fair reading -- not one -- of his speech could possibly lead any person to the conclusion that this was his only suggestion on the subject of regulation.
I understand that you disagree with McCain. I understand that you and 90% of the readership of this blog wants to see him lose next November. And that's all fine. But, please, at least attack him on the merits of his ideas.
von
p.s. Those who actually deal with SOx know that it created enormous cost to companies with marginal benefit to the public. We need smarter SOx, not mindless praising of SOx as SOx.
p.p.s. Love that Krugman is not slamming Greenspan as responsible for the housing market. Pray tell: Was Krugman leading the charge against the Fed rate cuts that Greenspan opposed? Or was he cheerleaing the cuts at the time, and even insinuation that they should go farther? Because, to the extent that you blame Greenspan at all for this mess, reducing the cost of borrowing has to be the doorstep on which his blame is laid.
Posted by: von | March 30, 2008 at 10:46 PM
Second pps should read:
"p.p.s. Love that Krugman is now slamming Greenspan as responsible for the housing market. Pray tell: Was Krugman leading the charge against the Fed rate cuts that Greenspan proposed? Or was he cheerleading the cuts at the time, and even insinuating that they should go farther? Because, to the extent that you blame Greenspan at all for this mess, reducing the cost of borrowing has to be the doorstep on which that blame is laid.
Posted by: von | March 30, 2008 at 10:49 PM
And "farther" should be "further." See? You've gotten me so wound up I've Ygesiasified myself.
BTW, Hilzoy: I still respect you enormously, appreciate your integrity, & think that you're a very sincere and effective blogger. But this post is just wrong on so many levels.
Posted by: von | March 30, 2008 at 10:52 PM
von: as the title of this post indicates, the topic is Gramm, not McCain's speech.
You're right that I mischaracterized what McCain said; I was thinking of his response to the shadow banking side of the crisis, not the bad mortgages side, and should have said so. I have updated accordingly.
I mean: I really don't see any new regulations to deal with anything other than mortgage lending. The only time regulation enters the picture, in dealing with those institutions that assumed excessive risk in buying financial instruments they did not understand, and who now expect taxpayers to assume large risks to bail them out, he's proposing to cut it.
That said, I should absolutely have said that I was thinking of his response to that side of the problem when I wrote what I did, and, as I said, I've updated accordingly.
Posted by: hilzoy | March 30, 2008 at 11:12 PM
Thanks, Hilzoy. I appreciate it.
Posted by: von | March 31, 2008 at 12:22 AM
hilzoy,
I have to add my voice to von's here - while Phil Gramm is IMHO evil even by the admittedly low standards of an American politician, it was grossly unfair of you to mischaracterize McCain's speech using guilt by association with Gramm, making this post seem more like a partisan hit job than a fair evaluation of McCain's merits from an econ standpoint.
From my not-very right wing point of view, if you subtract out the standard boilerplate GOP talking points about low taxes (which were not related in any way to the specific issues of the mortgage and credit market crises that are the focus of this speech), then McCain's speech was the best, by far, of any of the speeches given to date by the remaining presidential candidates on this topic. I hope to hear something better than this coming from Obama, but I'm still waiting.
To quote from some portions of McCain's speech:
"our financial markets experienced another round of upheaval. This market turmoil leaves many Americans feeling both concerned and angry. People see the value of their homes fall at the same time that the price of gasoline and food is rising. Already tight household budgets are getting tighter. A lot of Americans read the headlines about credit crunches and liquidity crises and ask: 'How did we get here?' In the end, the motivation and behaviors that caused the current crisis are not terribly complicated, even though the alphabet soup of financial instruments is complex. The past decade witnessed the largest increase in home ownership in the past 50 years. Home ownership is part of the American dream, and we want as many Americans as possible to be able to afford their own home. But in the process of a huge, and largely positive, upturn in home construction and ownership, a housing bubble was created.
A bubble occurs when prices are driven up too quickly, speculators move into markets, and these players begin to suspend the normal rules of risk and assume that prices can only move up - but never down. We've seen this kind of bubble before -- in the late 1990s, we had the technology bubble, when money poured into technology stocks and people assumed that those stock values would rise indefinitely. Between 2001 and 2006, housing prices rose by nearly 15 percent every year. The normal market forces of people buying and selling their homes were overwhelmed by rampant speculation. Our system of market checks and balances did not correct this until the bubble burst."
If someone can find and post a speech by either Hillary or Obama which does a better job than this of summarizing in plain nontechnical language both the subprime crisis and the subsequent liquidity crisis in the credit markets then please do so, because I haven't seen one.
"The other part of what happened was an explosion of complex financial instruments that weren't particularly well understood by even the most sophisticated banks, lenders and hedge funds. To make matters worse, these instruments -- which basically bundled together mortgages and sold them to others to spread risk throughout our capital markets -- were mostly off-balance sheets, and hidden from scrutiny. In other words, the housing bubble was made worse by a series of complex, inter-connected financial bets that were not transparent or fully understood. That means they weren't always managed wisely because people couldn't properly quantify the risk or the value of these bets. And because these instruments were bundled and sold and resold, it became harder and harder to find and connect up a real lender with a real borrower. Capital markets work best when there is both accountability and transparency. In the case of our current crisis, both were lacking.
Because managers did not fully understand the complex financial instruments and because there was insufficient transparency when they did try to learn, the initial losses spawned a crisis of confidence in the markets. Market players are increasingly unnerved by the uncertainty surrounding the level of risk, liability and loss currently in the financial system. Banks no longer trust each other and are increasingly unwilling to put their money to work. Credit is drying up and liquidity is now severely limited -- and small business and hard-working families find themselves unable to get their usual loans.
The net result is the crisis we face. What started as a problem in subprime loans has now convulsed the entire financial system."
Again, this is by far the best common sense explanation of where we are (and how we've gotten to this point) that I've heard from any major political figure. If McCain doesn't understand our economy then somebody who does is writing a damn fine speech for him in these passages.
"I have always been committed to the principle that it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers. Government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy."
I see nothing to quarrel with in this statement. McCain goes on to make a distinction between speculators and other homeowners which I think will be very difficult to make in practice rather than in theory, so I take some points off for that.
Other parts of his speech have already been defended by von, some I'll skip ahead to:
"I am prepared to examine new proposals and evaluate them based on these principals. But I think we need to do two things right away. First, it is time to convene a meeting of the nation's accounting professionals to discuss the current mark to market accounting systems. We are witnessing an unprecedented situation as banks and investors try to determine the appropriate value of the assets they are holding and there is widespread concern that this approach is exacerbating the credit crunch."
This is a key point. There is a non-trivial risk of a very rapid unwind of the banking system (i.e., a 1930 style run on the banks) due to the procyclical nature of mark-to-market rules and the way that they create a positive feedback loop between balance sheets and leverage both going up (the bubble) and going down (the crash). See for example the post by Yves Smith at www.nakedcapitalism.com on this subject, and the academic paper by Tobias
Adrian (NY FRB) and Hyun Song Shin (Princeton Univ.) which Yves links to.
Any surgery on the banking system to defuse this crisis is going to require very careful attention to this point. The fact that McCain mentioned mark-to-market accounting rules specifically suggests to me that he is getting excellent advice on this subject, at a level of detail that is impressive.
If Phil Gramm's evil fingerprints are to found on McCain's economic policy, you're going to have to look elsewhere for convincing evidence.
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 01:13 AM
It looks like I posted a broken link to that Yves Smith article, so I'm going to try again:
Did Mark-to-Market Accounting Create the Credit Bubble?
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 01:56 AM
TLTIABQ: As I said, the main point was Gramm. He is, in fact, McCain's main economic advisor and campaign co-chair. That is scary.
About the speech: I thought the explanation was excellent. But the rest I didn't like at all. To start with: I see exactly no help for homeowners now, as opposed to people who might purchase homes in the future. I think this is wrong. Yes, you don't want to reward speculators, but there are ways of doing that other than asking banks to help out and hoping for the best, which is what I see him doing.
There is nothing at all, as far as I can see, to deal with the fact that we now have financial institutions, like Bear Stearns, which can pose systemic risks, and therefore might need to be bailed out, but are not regulated in such a way as to prevent us from having to bail them out. When we decided to provide deposit insurance to prevent runs on banks, we also regulated banks to prevent them from doing stupid things that might make us have to bail them out. We deregulated the S&L industry, and ended up having to bail them out. If we are going to be in the business of bailing out the likes of Bear Stearns, we need to regulate them as well.
Mark to market: I haven't read the paper, just the post. I'm aware of the controversy. However, while I can imagine some tweaks to it (mark to six month rolling average of market?), the basic idea of mark to market is one I'd be reluctant to ditch.
I mean: you have to value an asset some way or other. Mark to model seems to me to open the door to all kinds of ghastliness and wishful thinking. Valuing them at market price is vastly better than that. Plus, this is how we do all sorts of things. Obviously, my net worth goes down when other people in my neighborhood decide to sell their homes and no one wants to buy them. Why? Because it includes the value of my house, which I estimate by looking at, well, the housing market. When my net worth drops, I might, in fact, spend less, and this might exacerbate whatever conditions led to the original problems with home sales.
But this "vicious circle" doesn't normally lead us to suggest that I should find some other way of valuing my assets, one that will allow my net worth to remain high even when their market value plummets.
Plus, if the drop in value is not temporary -- if it's not just a matter of investors overreacting, but a longish-term drop in value -- then presumably that drop ought to be reflected in a firm's balance sheets.
As I said, I can see responding to the problem of investors overreacting, thereby causing both excessive apparent value (when they overvalue stuff) and insufficient apparent value (when they flee the market), by using some sort of rolling average of market prices. But I don't think it would be good to ditch the whole concept.
In any case, the idea that this, plus undoing regulation, is pretty much it, as far as fixes to the financial system -- no increased capital requirements, for instance -- just strikes me as completely wrong, and of a piece with McCain's failure to do anything about the problem of foreclosures on non-speculators.
Posted by: hilzoy | March 31, 2008 at 02:00 AM
I should add: accounting is, obviously, not my long suit, so I am completely prepared to be totally wrong on this one. I just don't see my wrongness yet.
Possibly I should update to say: this post is not, primarily, about M's speech. That was a lead-in.
Posted by: hilzoy | March 31, 2008 at 02:08 AM
Possibly I should update to say: this post is not, primarily, about M's speech. That was a lead-in.
I apologise for the length of this comment, but this is a complicated topic.
McCain speech really should not have been addressed at all in the same post as the problems regarding Phil Gramm, unless you can point to something in the speech that has Phil Gramm's fingerprints on it. I didn't see anything specific in the parts of the speech relevant to the housing and credit crisis that meets that criteria.
Regarding McCain's speech, I didn't take away from it that McCain is looking to abandon ordinary folks who are blameless victims of the housing bubble. At several points in the speech he specifically excludes them from the jabs he takes at speculators and lenders.
The question of whether we should do anything to try to prevent foreclosures is a complex one and I for one do not see it in traditional left-right terms. Any measures which temporarily slow down the process of foreclosure are helping the people occupying these homes only if they succeed in saving their homes in the end.
Otherwise, all we are doing is ensuring that more of their income is thrown away futilely trying to hang on to an asset that they are going to lose regardless. People who are eventually going to lose their homes in the end would be better off being foreclosed on now and receiving some assistance in obtaining affordable shelter as renters at lower rates per month (than their mortgage payments), rather than being encouraged to pour more of their future earnings into an asset from which they will never be able to extract equity.
The housing crisis bears some resemblance to the Iraq war "surge" in this regard - what is the point of wasting additional resources in postponing the inevitable?
The other problem with having the US Govt. provide support to struggling homeowners is that to the extent it succeeds it will have the effect of propping up home prices rather than letting them drop back down to their historic norms in terms of value-to-income ratios. This is not doing working-class people any favors. If you want to put home ownership forever beyond the reach of them, having the US Govt. get into the business of supporting inflated home prices is as good a way as any I can think of to do it.
Lastly, the plans I've read coming from the Democratic candidates thus far don't suggest a realistic understanding of the size of the problem. Both home ownership rates and debt to income ratios rose above their norms during the bubble. I've read convincing number-crunching exercises on some of the econ blogs (calculatedrisk and the Yves Smith blog I linked to earlier for example) which suggest that the overhang we will have to deal with if both of these metrics revert to norm is somewhere in the range of 2 trillion to 8 trillion dollars for the US market alone. A 30 billion dollar package is a drop in the bucket compared with these numbers. The cruel fact is that there is very little the US Govt. can do to help homeowners, because the problem is so much larger than any conceivable fiscal package we can possibly afford to pass, and any attempt to evade this reality will most likely do more harm than good.
What I got from McCain's speech is that we can't make fixed plans for how to solve this crisis right now, because we are still trying to understand how it is going to unfold, and he would rather do nothing than take steps which may make things worse rather than better. That may sound like traditional GOP heartlessness, but to me it seems like a realistic assessment of where we stand right now and how big the problem really is.
My take on the data and analysis I've been able to glean is that the economy is heading rapidly towards what in complex systems theory is called a critical point. That is a point beyond which the future state of the system is wildly unpredictable based on the current state. We could be headed for a wide variety of outcomes ranging from a deflationary 1930's style Depression to Weimer Republic style hyperinflation. Bold measures to try to fix what we think is the problem at the present time carry a considerable risk of making one of these extreme outcomes more likely rather than less likely. The least-bad scenario with a high likelihood looks to me like some combination of USA 1970's stagflation and 1990's Japanese slow deflation frozen in place by mark-to-model accounting rules.
McCain's speech sounded to me like exactly what I would expect to hear from somebody who knows this and is aiming for the least-bad outcome I just outlined, by trying not to steer too hard to one side or the other until we have a better picture as to which side of the road we are in greater danger of sliding off of. I say this as someone predisposed to think poorly of McCain and primed (prior to his speech) by the idea that he knew the least about economics of the 3 presidential contenders. His speech has forced me to reevaluate my opinions in that area.
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 04:05 AM
I believe one of Sen. Clinton's proposals is to allow bankruptcy courts to revalue mortgage amounts. The big concern I've heard about this, aside from the challenge of figuring out where those mortgages are held, is that it will drive future mortgage rates through the roof: if lenders cannot be assured that the assed will retain its nominal value, they will demand higher interest payments.
Anyone more knowledgeable wish to comment?
Posted by: farmgirl | March 31, 2008 at 08:57 AM
oh dear -- that's "asset"
Posted by: farmgirl | March 31, 2008 at 09:04 AM
Farmgirl -
I believe one of Sen. Clinton's proposals is to allow bankruptcy courts to revalue mortgage amounts. The big concern I've heard about this, aside from the challenge of figuring out where those mortgages are held, is that it will drive future mortgage rates through the roof: if lenders cannot be assured that the assed will retain its nominal value, they will demand higher interest payments.
That is exactly what one would expect. If you increase risk to a lender then the lender will charge more interest.
Hilzoy, I understand that you intended this post to slam Phil Gramm and, by association, McCain as well. It's a classic political hit job -- the kind of guilt by association that you also see with Obama/Wright fiasco.
Respectfully, your error was to try to give a political attack the clothes of substance. Unless it's a dead-on connection (e.g., Gramm authored the speech), that's already a stretch. Worse is that McCain's substance here was very good; better than anything we've yet heard from Obama or Clinton.
Posted by: von | March 31, 2008 at 09:28 AM
von: I'd think the comparison to Wright was more convincing had Wright ever advised Obama on any policy question, let alone been one of his main advisors on a huge swath of policy. Or: been the co-chair of his campaign. Or: been spoken of as Obama's future Secretary of anything.
McCain, by his own admission, doesn't know much about economics. I think it's therefore very important to see who's advising him on the economy. I don't think it's "guilt by association" at all, since Gramm is not just an associate: he's someone who actually advises McCain on some pretty serious questions.
Posted by: hilzoy | March 31, 2008 at 09:39 AM
I mean, would you think that explaining what you thought was wrong with Obama's main foreign policy person's views on foreign policy was just "guilt by association"? I wouldn't.
Posted by: hilzoy | March 31, 2008 at 09:40 AM
McCain, by his own admission, doesn't know much about economics. I think it's therefore very important to see who's advising him on the economy. I don't think it's "guilt by association" at all, since Gramm is not just an associate: he's someone who actually advises McCain on some pretty serious questions.
I don't know that you have pointed to any evidence whatsoever to support that claim, and McCain's speech shows the opposite with respect to the housing crisis. I care less than who came up with the ideas and care more about what the ideas are.
von: I'd think the comparison to Wright was more convincing had Wright ever advised Obama on any policy question, let alone been one of his main advisors on a huge swath of policy. Or: been the co-chair of his campaign. Or: been spoken of as Obama's future Secretary of anything.
You know, I could say that Obama credited Wright as have a deeply personal and spiritual affect on him. Wright undoubtably has had greater influence on Obama than Gramm has (or will ever have) on McCain. But what I'd rather do is get back to my point: I don't give a flying rat's ass about Wright, because Wright isn't the candidate. For similar reasons, I don't give a flying rat's ass about Gramm.
And I particularly don't give credit to arguments that attack the messenger at the expense of the message. That's your argument, Hilzoy. It's rife with ad hominem fallacies.
Posted by: von | March 31, 2008 at 10:14 AM
When I say that this post is rife with ad hominem fallacies, I actually may be giving it too much credit. It's not: The man's argument is wrong because the man is a bad man (the ad hominem fallacy). It's: The man's argument is wrong because the man is associated with some other man, and this other man is a bad man (the "ad hominem, one step removed" fallacy, I suppose).
(The same applies to the attacks on Obama via Wright.)
Posted by: von | March 31, 2008 at 10:21 AM
The passages of McCain's explanations quoted are better than you'll get from a lot of the news, but there's an awful lot of the passive voice.
I'm talking about the difference between
"Eight dead in Hilla as violence erupts" and "U.S. planes bomb city, kill 8". Translated to mortgage lending and the purchase and evaluation of mortgage securities.
Posted by: Nell | March 31, 2008 at 10:33 AM
von, are you saying that discussion of the public records of individuals who might be appointed to senior government positions is not a legitimate topic during a political campaign?
McCain's speech may well have pointed out the obvious (speculative bubbles are bad) but he fails to identify the real problem (poorly regulated securities).
Given the succession of appointments of incompetent and corrupt senior officials in the current administration I think this discussion is in order.
Posted by: ral | March 31, 2008 at 10:34 AM
von: it's not "Gramm is a bad man", it's "Gramm's record is one of trying to unregulate any financial anything that moves, including in ways that contributed to several financial meltdowns, one of which McCain will, if elected, be charged with helping to fix." Again, if you think that this feature of an advisor is irrelevant to a candidate, OK.
Also, if you think that economics is McCains long suit, so that he won't need any advisors, fine. For my part, I don't.
Heading out for Karachi shortly, so if I don't respond, that's why.
Posted by: hilzoy | March 31, 2008 at 10:36 AM
I posted a lengthy analysis of McCain's speech on Friday, and it'd be innappropriate for me to regurgitate it here. But I did feel compelled to jump in to this debate when I saw Von, ThatLeftTurn, and other posters attempt to defend the substance of McCain's remarks.
The only possible defense of McCain is the one advanced by ThatLeftTurn, that he's "aiming for the least-bad outcome" - that is, to take his vague proposals and refusal to formulate a substantive response to the crisis as a virtue, evidence of his wisdom and patience in not rushing to judgment. The problem is that you'd be hard pressed to find an economic policy expert who believes that non-intervention is a viable policy at this juncture.
As for Von's contention that McCain is actually calling for regulation - I'd respectfully dissent. The long passage he quoted speaks artfully of desired outcomes - McCain would like borrowers to be able to understand what they're signing, there should be standards for lenders, they should be held accountable - but there's no mechanism detailed for any of this. Nor, for that matter, does McCain mention any of these things in his account of what's gone wrong. And there's good reason to think he's not talking about regulation - when he says we need to do two things right away, both involve convening industry representatives and asking them to work out a solution. That seems to be McCain's prefered method of correcting problems - not regulation, which implies government intervention, but voluntary industry compliance.
There's only one explicit call for new regulation (as opposed to new practices) and it's in respect to GSEs and downpayments. When it comes to imposing requirements on borrowers, McCain isn't nearly as shy. There's no call for, say, a national conversation to ask borrowers to agree to act more responsibly in the future. (And if that sounds absurd, ask yourself why a call to sit down with lenders isn't equally ridiculous.)
There's a reason for this - it's what I lable McCain's Double Standard in my post. McCain, like most Republicans, views financial failure as indicative of moral failure - borrowers who have defaulted have erred, and need to suffer for their sins. Period. Market failures, on the other hand, reflect the presence of some confounding factor, since free markets ought to be perfectly efficient. So if the market has failed, it's because there was insufficient transparency and excessive complexity - not because its participants did anything wrong. (I challenge you to find a section of the speech in which McCain pins any portion of the blame for this mess on financiers.) The upshot is that McCain blames borrowers for their irresponsible speculation, buying a home by signing a mortgage they didn't fully understand, thereby shouldering risk they failed to manage properly. But bankers, who irresponsibly speculated by creating and trading in complicated securities they didn't fully understand, thereby shouldering risk they failed to manage properly, aren't to be blamed. On the contrary. We need to cut regulation to enable them to replenish their capital, and then cut taxes so that they won't be unduly restrained from maximizing profits.
There's a reason why Hilzoy's length exploration of the career of Phil Gramm is worth reading. McCain shares Gramm's view of the world, in which success and failure are matters of moral virtue, and government intervention only perverts incentives. That's important for voters to understand. Most Americans believe something a little more complicated - that the government has an important role to play in ensuring that equality of opportunity is real, and not illusory. That's how McCain is able to say, with a straight face, that borrowers can stay in their homes by "working a second job, skipping a vacation, and managing their budgets -- to make their payments on time" as if it were the profligacy or laziness of four million homeowners that has placed them in default. And it's why his economic views are even further from the mainstream than his foreign policy notions - and that's saying something.
Posted by: FlyOnTneWall | March 31, 2008 at 10:40 AM
hilzoy, safe trip to you.
Posted by: ral | March 31, 2008 at 10:41 AM
Von, ThatLeftTurninABQ, and FlyOnTheWall make good points, some of which I'll try to address later today.
Yes, this crisis is incredibly complicated.
Two points:
Douglas Holtz-Eakin is probably McCain's closest formal economic advisor in the employ of his campaign. I'll bet many of his words found their way into McCain's speech.
And, Phil Gramm is McCain's closest friend.
Also, Gramm is a former Democrat -- well, Texas=style.
As to ad hominum attacks on Gramm, namely mine above -- I'll stand by my comment and even counter Hilzoy's "It's not that 'Gramm is a bad man," by stating that, indeed, in my opinion, Gramm is a bad, corrupt man.
His career is one long series of ad hom attacks on his political and ideological enemies.
Worse, his involvement in shaping McCain's economic policy signifies some things about the tenor and direction of McCain's economic programs.
I suppose we could compare Gramm's involvement here to FDR's appointment of Joseph Kennedy Sr. in the early 1930s as first head of the S.E.C. ---- the corrupt fox who knows his way around the henhouse.
Posted by: John Thullen | March 31, 2008 at 11:04 AM
As to substance, the notion that there's too much regulation of financial institutions is absurd.
Whether it is tulips, commodity futures, energy futures or mortgages, the result is always the same.
Unregulated securities are a license to steal. Period.
Posted by: ral | March 31, 2008 at 11:11 AM
hilzoy,
I think part of the problem I have with your argument is that while Phil Gramm is personally responsible for some of the deregulation of the banking industry which made the housing bubble possible, it does not necessarily follow that doing the opposite of what Phil Gramm would do is the wisest course of action at the present moment. I agree that John McCain is showing poor judgment in choosing Phil Gramm as an advisor (and I don’t see the Wright controversy as analogous), but the speech McCain gave does not support the argument that this poor judgment has manifested itself in the form of poor policy.
The core of the problem as I see it is leverage, and the extent to which it was used both by actors in the credit markets and by individual home borrowers on such a large scale that they are now deemed too large to fail. We have two tasks to accomplish in fixing this mess, but they have very different time frames.
The longer term one is to shut the door so future bubbles like this cannot happen again. This will involve imposing regulatory limits on the use of leverage, both at the level of the individual borrower (e.g. require minimum down payments), and at the level of the banking system and the shadow banking system (e.g. impose stricter minimum capital requirements and clamp down on accounting practices which can be used to evade these requirements, such as holding certain classes of assets off balance sheet).
The shorter term problem is to defuse a volatile situation where highly leveraged institutions and individuals are at risk of a catastrophic deleveraging of their current positions (a 1930 style bank run). The dilemma is that the regulatory changes needed to solve the long term problem are likely to make the short term problem worse rather than better, because the regulations required to solve the long term problem are inherently deflationary in nature.
How we can reduce leverage in the short term without triggering a crisis is not at all obvious, since any attempts to force a deleveraging by regulation will result in a rapid unwinding of the positions held by affected institutions all at once, which is exactly what we don’t want. We need to find a way to slowly deleverage the banks in stages; that is why I think that the temporary use of mark-to-model rules may be something we need to look at in the short term, as a tool to slow down and compartmentalize this process.
In the broadest sense there are really only two long term solutions for a solvency crisis this large: attract a large influx of foreign money to recapitalize our banks, and/or go through a period of enforced savings (i.e. depressed living standards) in order to recapitalize our economy from the grass roots up. To solve this problem we need to buy time for these solutions to come in to play (they will not do so quickly) while preventing a catastrophic unwind in the short term. Once that process is well underway, then we will be able to impose the regulatory regime needed to stop the next bubble from inflating.
The other thing we should be doing is putting in place policies which ensure that as the economy is recapitalized from below, i.e. basically on the backs of working class and middle class people, that the sacrifices they make are translated into a greater share of income and a greater share of the net worth of the nation, than they enjoy now. The New Deal and the effects it had on income distribution provide a template here, but first we have to deal with the short term crisis if we don’t want a 2nd Great Depression to be the road taken to get to that point.
The alternative is to render our debt meaningless via a hyperinflationary monetary policy, which is the strategy the govt. of the Weimar Republic used to repudiate their reparations. I don’t think anyone wants to go that route.
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 11:28 AM
FlyOnTneWall, regarding your analysis at TPM as well as your comment here: You're reading an awful lot into McCain's speech -- except where McCain calls for greater controls, where you conclude that he can't actually be suggesting additional regulations.
Posted by: von | March 31, 2008 at 11:41 AM
Ral -
There's so much wrong going on here that I'm not sure it's even worth a comment, but here goes:
Your examples ("tulips, commodity futures, energy futures or mortgages") are completely different from one another. Disruptions in the markets for commodity futures, energy futures or mortgages had completely different causes and radically different effects. Nor do they relate in any sense to the supposed tulip crisis of mercantilist, 1600s Dutch society. It also bears noting that there's very little evidence that actually supports the existence of any such crisis -- which was first noted in a book written 200 years later -- or actually represented a market failure.
2. Contrary to your conclusion, causes and effects matter when judging the wisdom of any particular regulation.
Posted by: von | March 31, 2008 at 12:12 PM
von, you have to be kidding. Granted I am making brief blanket statements but others are providing details. I am trying to get to the heart of the matter, which in my view is, inadequate regulation of financial instruments always leads to theft on a large scale. Damage from such theft is sometimes limited but can lead to serious disruption of society.
Now to be sure once this basic principle is agreed the precise nature of regulation has to be carefully considered (see ThatLeftTurnInABQ, above) but do you disagree with my premise?
Posted by: ral | March 31, 2008 at 12:22 PM
Oh, and the common cause is very simple: greed.
Posted by: ral | March 31, 2008 at 12:26 PM
I'm not an economist, so I need some help in keeping up. A couple of quick questions:
Does anyone know McCain's position on the $29-$30 billion in guarantees the Fed is providing for Bear Stearns' 'hard to value' paper?
Who funds the Fed?
Have any proposals been put forward for any similar guarantees for 'hard to value' home mortgages that are in danger of foreclosure?
If so, what's the price tag for those guarantees?
Thanks -
Posted by: russell | March 31, 2008 at 01:23 PM
I am trying to get to the heart of the matter, which in my view is, inadequate regulation of financial instruments always leads to theft on a large scale. .... Now to be sure once this basic principle is agreed the precise nature of regulation has to be carefully considered (see ThatLeftTurnInABQ, above) but do you disagree with my premise?
Yes. Taken from your own list of examples: The collapse of the Dutch futures market for tulips, assuming that it occurred on any large scale, was likely the result of "overregulation"* -- not underregulation. The rules provided a very small cancelation fee in proportion to the option price. So: You could bid an enormous price for the option to purchase a tulip bulb in the future but, if things didn't turn out so well when the future became present, cancel the option at virtually no cost. With no opportunity for buyers or sellers to enter into different contracts, one got a predictable run-up in the price of tulip options. Equally predictable, the price crashed when large parts of the market decided that they didn't want to buy at the optioned price.
von
*In fact, the issue is not "over" or "under" regulation, but proper regulation. We need to stop with the binary "more" v. "less" thinking. It's not helpful.
Posted by: von | March 31, 2008 at 01:34 PM
I took a look at the link TLTIABQ provides on the mark-to-market issue. The argument seems to be that when banks mark assets to market they then do stupid things, so they shouldn't mark to market.
I don't find that a compelling argument. If banks are going to do stupid things they will do them under any set of accounting rules.
As to regulation, it is fair to say that:
Not "fingerprints," perhaps, but surely grounds for suspicion.
By the way,
You could bid an enormous price for the option to purchase a tulip bulb in the future but, if things didn't turn out so well when the future became present, cancel the option at virtually no cost.
If you're going to caim this as an example of overregulation you need a better explanation. The very essence of an option to buy something is that it's an option. If the price doesn't go as you hoped you don't have to exercise it. What government-mandated cancellation fees had to do with it is mysterious to me.
Posted by: Bernard Yomtov | March 31, 2008 at 02:15 PM
Von - I'm not convinced I'm reading anything at all into McCain's speech, just annotating the remarks he gave. I wish you'd explain why his suggestions for better practices amount to calls for regulation.
Perhaps the tulip example you cite is instructive - you seem to have mistaken contractual provisions for regulation. The procedure you describe, "on the plate," was but one of three commonly accepted ways of selling the bulbs. Most significantly, for our purposes, the first attempt to regulate the market didn't happen until February 7, 1637 - shortly after the bubble burst in Haarlem, rendering the futures worthless. And, amusingly, it was an attempt at self-regulation by the growers, who aimed at modest reforms that would minimize their losses. It eventually took intervention by the High Court of Holland to settle the mess. To prevent a recurrence and clear up the wreckage, most towns and trading centers set up Commissions, empowered to settle disputes in the trade. In other words, the tulip bubble is a classic example of an unregulated market leading to a self-reinforcing spiral of speculation - and ultimately to a crash. Alas, I also happen to agree with you that it's not directly relevant to understanding the economic policies of John McCain.
But I'm happy to engage this issue on your chosen terms. You've written that the real issue here is "proper regulation." With the exception of minimum downpayments, the reforms that McCain suggests all focus on a single issue - full and transparent disclosure. (That holds true irrespective of the mechanism - I think he's calling for lenders to police themselves, you think he wants regulation but for some strange reason can't bring himself to use the word - but either way, the reforms are the same.) He wants lenders to be more transparent, he wants the markets to be more transparent, and he wants financial firms to be more transparent.
All of this is firmly grounded in the rigid orthodoxy of classical economics. The theory is that any two actors with full and equal access to information and acting of their own free wills, ought to be able to engage in transactions without governmental interference. So when McCain looks at the lending landscape or at the financial markets, he's willing to acknowledge that we have a problem with excessive complexity - that is, that the transactions have ceased to be transparent. The solution, therefore, is to demand better disclosure and less complexity.
Color me unconvinced. It may be that full disclosure of prepayment penalties in clear and plain language would have saved some borrowers - but for the most part, borrowers appear to have been dimly aware of the provision, just unconvinced it would matter to them. I can't think of any defense for a financial institution imposing a prepayment penalty on a loan - that is, provided the interests being pursued are societal. It's a classic abusive practice, and it ought to be banned (as indeed, it's starting to be.) But no word of this in McCain's speech. Linking adjustable rates to fluxuations in a credit score is similarly predatory - some folks prioritized making their mortgage payments, only to find that in reward for that prudent measure, the higher balances they were carrying on their credit cards jacked up their rates, putting them even further behind. Again, indefensible, even if there'd been full and fair disclosure.
That's my basic problem with the Gramm/McCain approach. There's just no room in their view of the world for practices that are inherently abusive, fraudulent, or predatory - even when they're fully disclosed. They assume that full and fair disclosure is adequate to prevent such abuses, when we have centuries worth of evidence that it's not. And though McCain and Gramm are tempted to blame the parties who imprudently engage in such transactions, the current mess shows the hazzards of that approach - a smmal number of imprudent borrowers in a single neighborhood can be forced into foreclosures that drag down housing values (perhaps forcing additional foreclosures among blameless borrowers), raise crime, and increase the burden on the remaining taxpayers. Similarly, a handful of bad actors in a market can wreak significant havoc. The price, on other words, is paid not just by those who engage in the transactions, but by all of us. That's why we have regulation in the first place - not just to ensure transparency, but to guard against the dangers inherent in markets. And McCain doesn't appear to get that.
Posted by: FlyOnTneWall | March 31, 2008 at 02:21 PM
Bernard,
It took me a few minutes to figure out what Von was talking about, too. He's riffing off a too-clever-by-half article by UCLA and BU economists Earl A Thompson and Jonathan Treussard. It's a spiffy-piece of market modeling, in the Freakonomics tradition of making a counterintuitive point about a well-known trend or event. But it has a critical flaw - the basic facts in the piece are largely incorrect. It's the danger of getting your history from economists. Treussard has since repudiated the article. But it lives on in Wikipedia, among other places - and it's such an appealing notion to free market dogmatists that it's unlikely to ever dissappear.
Posted by: FlyOnTneWall | March 31, 2008 at 02:27 PM
Gramm's recommendations are bad economics, bad public policy, bad for Wall Street and bad for the country. I don't really care whether Gramm is evil or not. While I do see some gratuitious shots taken at Gramm, they do not appear to be the argument against McCain using Gramm as an advisor.
It is foolish of John McCain to choose Gramm as an economics advisor because Gramm is an ideologue who allows his ideological opposition to regulation to blind him to all of the experience in the markets that has shown that unregulated markets fail and are corrupted and that lightly but carefully regulated markets work more smoothly.
I think that it is useful to have extremists like Gramm in positions where they are heard on a regular basis, if only to defend against unthinking commitment to too much regulation, but he would be a disaster in a position of real power.
Posted by: Free Lunch | March 31, 2008 at 02:38 PM
And let's not forget that Gramm was instrumental is blocking a law the Clinton administration was trying to push through to allow better international tracking of terrorist funding. You can read a 2001 article on it here. Money quote:
Summers' bill passed the House Banking Committee 31 to 1 in July 2000, but it got no further. Republican Senator Phil Gramm of Texas, chairman of the Senate Banking Committee, refused to let it come up for a vote in his committee.
He single-handedly refused to let the gov't strengthen its ability to track terrorist finances. What kind of pay-off did he get for that move? (Some of it is in the article.)
Is this really the right kind of person to pull in as your financial expert? McCain's judgment seems to be faulty on more topics than Iraq.
Posted by: LFC | March 31, 2008 at 02:38 PM
I took a look at the link TLTIABQ provides on the mark-to-market issue. The argument seems to be that when banks mark assets to market they then do stupid things, so they shouldn't mark to market.
I don't find that a compelling argument. If banks are going to do stupid things they will do them under any set of accounting rules.
Bernard,
My take from that paper is that if we wish them to be sustainable the banks should not try to maintain a constant level of leverage under Mark-to-Market rules as the assets on their books inflate in value during a systemic asset inflation (i.e. a bubble), because doing so sets up a trap whereby a systemic deflation of the same assets will increase their leverage at the precise time that this is the worst possible outcome, leading to a positive feedback loop (i.e. a death spiral) in deleveraging.
Instead banks should be required to decrease their leverage when there is evidence of an asset bubble. Note that such evidence was plentiful for those who wished to see it during the housing bubble.
The problem was that:
(a) banks had a very strong incentive to try to maintain a constant level of leverage because otherwise they would have been delivering a reduced rate of return against their deposits, at a time when they were in competition with shadow banking entities driven by the need to deliver higher rates of return (at the cost of greatly increased risk, most of which was concealed by the opaque nature of their instruments)
and
(b) the regulatory regime the banks were subject to was not designed to impose rising capital requirements (i.e. require larger deposits) in response to a systemic asset inflation.
My point is that (a) we need smarter regulations which take things like this into account and which create firewalls designed to inhibit positive feedback loops from being built into the financial system, and (b) the present moment is a very dangerous time to do this because the feedback loops already built in to our system as it exists today have not yet been unwound. We need to defuse the bombs built in to our current financial system first, then put barriers in place to prevent them from being rebuilt. These are two different tasks which require different tools and approaches.
Note that even if the same regulatory regime had been in place to control the shadow banking system (as was applied to the banks proper), we would still be at risk of a positive-feedback induced deleveraging. In fact these same dynamics were why some observers objected to the expansion of the balance sheets being carried by the GSE’s, and saw the contraction of their portfolios several years ago as a good thing (http://www.nakedcapitalism.com/2008/03/systemic-risk-from-outsized-fannie-and.html”>which is now being reversed under political pressure to make the GSE’s help staunch the bleeding in the current mortgage crisis).
Also, I’m making a point of quoting from Yves Smith here because his blog is generally more left leaning (without descending to the level of conspiracy minded rants) than the others I’ve found which cover this topic in detail, so I’m going out of my way not to quote from GOP friendly sources here in order to avoid accusations of right wing bias.
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 03:28 PM
It took me a few minutes to figure out what Von was talking about, too. He's riffing off a too-clever-by-half article by UCLA and BU economists Earl A Thompson and Jonathan Treussard.
What? That's not the only article that suggests that Charles MacKay's version of the bubble story -- written nearly two centuries after the fact to serve political intersts of his time -- was inaccurate. (You don't have to accept any of the revised histories of the tulip story or agree with me, but I hope that you at least agree that the MacKay version is suspect.)
As for McCain: He's not merely pushing transparency; he's also pushing for higher equity requirements in home loans, so that lenders are restricted in selling "nothing down" loans to borrowers. (These would be the loans that are more likely to include your "predatory" features.) (Not my term, obviously.)
Posted by: von | March 31, 2008 at 03:39 PM
ABQ,
Yes. The point about keeping constant leverage makes sense, but I still don't know why banks are somehow compelled to do this. You say it is to maintain a competitive rate of return on deposits, but I don't see how that works. It seems to me that failure to increase leverage when asset prices rise will affect return on capital, but how that translates into return on deposits I don't get. This stuff gets tricky, so you might be right, but I don't see it.
Even then, it looks like accounting conventions are obscuring reality. Banks know, or should know, that to the extent capital growth is based on an increase in relatively risky assets that growth does not justify proportionately incresed lending, especially when the marginal loans are themselves riskier than average, as they surely will be.
Again, I'm not denying the problem, just suggesting that unwise management plays a big role, and blaming it on mark-t-market accounting seems silly. It's not as if historical cost accounting for bank assets didn't create some problems also.
That said, it is impossible to disagree that we need smarter regulation, as opposed to the dumber kind, and that there needs to be some time for things to unwind a bit.
Still, I think that smarter regulation needs to cover non-banks as well, especially since they do operate, perhaps inevitably, under implicit federal guarantees.
Posted by: Bernard Yomtov | March 31, 2008 at 04:27 PM
Von - I didn't defend MacKay in my post. In fact, I can't think of a nineteenth century work of history that isn't in need of some revision, and I linked to Anne Goldgar's recent work which challenges MacKay on any number of key points. The reason I assumed that you were relying upon Thompson and Treussard was your claim that the tulip bubble was caused by regulation - specifically, by fixing the cancellation fees. I'm unaware of other scholars who make that claim - it's manifestly wrong. Tulipmania wasn't the economic catastrophe that MacKay made it out to be, but it was a bubble - and it was caused by a market feedback-loop that regulation would have prevented, as indeed it subsequently did.
As for McCain, I was careful to qualify my statements by saying "With the exception of minimum downpayments." Yes, it's clear that McCain is quite willing to impose that requirement, and it's a good one - although the FHA has already made such loans virtually obsolete, so it's not clear to me exactly what McCain's proposing that's new here. But even here, he frames it as a requirement for borrowers, not for lenders - that is, he's willing to allow for the need to crack down on people trying to borrow imprudently, but sees no similar problem with those trying to lend imprudently.
Posted by: FlyOnTneWall | March 31, 2008 at 04:46 PM
Banks know, or should know, that to the extent capital growth is based on an increase in relatively risky assets that growth does not justify proportionately incresed lending, especially when the marginal loans are themselves riskier than average, as they surely will be.
Bernard,
The problem as I understand it is that banks will only pursue policies which are tolerated by a sufficiently large mass of potential depositors. If a bank is too prudent when investor psychology is running the opposite direction during the craze phase of a bubble, then that bank will lose its deposits to competitors who are offering a better rate of return (at the hidden price of increased risk). The latter can offer higher rates of return because they are using greater leverage to derive larger profits from the money they carry on deposit than their more prudent cousins. This is bound to end badly, but during a craze nobody is thinking about long range problems [see note*]. Instead you get a race to the bottom, where the most irresponsible banks are the ones which are the most successful at attracting deposits and the more prudent ones are punished with a shrinking pool of deposits.
The purpose of regulation in this situation is to protect everybody involved (by placing limits on dangerous behavior) when the wisdom of crowds turns into the folly of mobs. You’ll know this is happening when you hear people saying "the old rules don't apply" or some variant thereof.
*note:
The factual assumption which is wrong in your statement above is the idea that banks (or more properly the people who run them) are more rational in their psychology than the average investor. The evidence for this idea is rather slim, to put it mildly.
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 05:31 PM
Von - I've read the whole speech, and this is the only think I can find that McCain proposes to actually do:
He will:
1) Listen to proposals
2) Convene a meeting of accounting professionals
3) Convene a meeting of mortgage lenders
Really, what new regulations is he proposing here? Are you suggesting that his saying transparency is good is the equivalent of proposing new regulations?
Posted by: MitchellDet | March 31, 2008 at 05:33 PM
ABQ,
Yes. It dawned on me. The higher capital base permits, in the current regulatory environment, banks to make more loans. These will necessarily be riskier/higher yielding than the existing portfolio.
Banks who do this will be able to offer higher rates on deposits, protected of course by deposit insurance. Those that don't will suffer, and the increased risk will be borne by the public.
Like I said, these things are tricky.
But this is no argument against mark-to-market. It's an argument for better regulation, more accurate classification of bank assets, more sensible deposit insurance premiums, etc.
The factual assumption which is wrong in your statement above is the idea that banks (or more properly the people who run them) are more rational in their psychology than the average investor. The evidence for this idea is rather slim, to put it mildly.
I try to avoid this error. (I've dealt with bankers). That's why I said "should know."
Posted by: Bernard Yomtov | March 31, 2008 at 05:46 PM
But this is no argument against mark-to-market. It's an argument for better regulation, more accurate classification of bank assets, more sensible deposit insurance premiums, etc.
Agreed. The reason mark-to-market come into the discussion is it increases the importance of getting these things (better regulation, etc.) right and putting them in place before a bubble occurs, because in their absence a bubble will be loaded with a positive feedback loop which makes the resulting downturn more dangerous than it otherwise would be.
The analogy I would use is that you should have the brakes checked on your car before you go driving the streets of San Francisco (mark-to-market) because hills are to be expected and you don’t want to accelerate out of control when you crest one of them and then head down the other side. If your brakes are shot and you aren’t going to do anything about it, you’d be safer driving somewhere else where the topography is flatter (mark-to-model).
Our present situation is that we are locked in car whose brakes were stolen by thieves some time ago and we are lost somewhere near the top of Telegraph Hill.
Posted by: ThatLeftTurnInABQ | March 31, 2008 at 06:11 PM
An unauthorized Great Stuff, All. Greatly admired your TPM piece, Fly, for reasons I commented on there.
Thanks.
Posted by: felix culpa | March 31, 2008 at 10:12 PM
"1)"People say I don't have a heart. I do. I keep it in a quart jar on my desk."
Add plagiarism to Gramm's dossier.
Von: "All of that is f_cking new regulation. All. Of. It. Did you not read it? Not understand it? Expect your readers not to read or understand it?"
Do you have a link to McCain's relevant bill, Von, rather than just a speech?
Because, in fact, a speech is not a proposed regulation. It's just rhetoric.
Call me slow, but I have trouble understanding a legal proposal until I can read the specific and precise language of the law.
Which bill McCain sponsored are you referring to that we can read to see exactly what "regulation" McCain proposes, please?
(I'm assuming that there is such a bill, and you're not berating us for not "understanding" a non-existent bill.)
Thanks.
Posted by: Gary Farber | April 01, 2008 at 03:01 PM
So, does perhaps anyone else know what bill Von is berating folks to read and understand?
I wouldn't want to be unfair to Senator McCain, myself.
Posted by: Gary Farber | April 02, 2008 at 10:37 AM
Since Hilzoy isn't around to catch and post this, yesterday's WaPo on Phil Gramm's importance to the McCain campaign.
It sure is important to have chief economic advisors on top of the details:
I can't decide if it would be better for Gramm to be Chair of the Board of Economic Advisors, or lead the Domestic Policy Council, or be Treasury Secretary, under John McCain, but if we're really really lucky, maybe he'll get all three jobs. God knows he's the best man for the job, and more than capable of handling all of them at once better than any other three people put together.I'm thinking "Total Information Unawareness" is a great approach to fiscal responsibilities. Hurrah for the grownup fiscally conservative Republicans!
I'm just so mad at the Democrats; if not for them, we could have invested everyone's Social Security taxes into the burgeoning and ever-growing housing market, and we'd all be rich, rich, rich! Damn the Democrats and all their irresponsible notions about PayGo, lockboxes, and balanced budgets! Damn them all to hell!!
Posted by: Gary Farber | April 02, 2008 at 12:13 PM
Gary, such language!
Darn them to heck if you must, but please, this is a family blog. Think of the children!
Posted by: ral | April 03, 2008 at 09:19 AM
"Think of the children!"
But.
Posted by: Gary Farber | April 03, 2008 at 09:44 AM
But.
Yeah. You new here? You never really get used to it, which is good.
Ya gotta be happy with the little things. But you were already predisposed, looks like.
Came across your Jane Jacobs piece from a couple of years ago /yesterday. Bit wierd at first to encounter her in the present tense, really good piece. Thanks.
Lived a block away from her for a couple of years. Trees, kids, professors, large not-large lots, one-way streets. Saw her with her walker visiting her daughter and grandchildren, now I think of it must have been her granddaughter and great-grandchildren. Maybe six hears ago.
V early 70’s was member of a food co-op she belonged to too. Remember her working cash. Good woman, nice lady.
Judith Merrill too. Only at a new-music place here. She was admiring my paintings. Glow.
Anyway, big congrats on the delegacy. Oughta be stupendous and historic. Also good on you for the move.
Posted by: felix culpa | April 03, 2008 at 04:01 PM
That said, let me once again state one other thing.
For Democrats to pile on Gramm about the Gramm-Leach-Bliley Act of 1999 is hypocritical. A majority of Democrats in both House and Senate voted for the bill. President Clinton was behind it from the start.
And, as the Observer story notes, Clinton Treasury Secretary Robert Rubin was a strong supporter of the Commodity Futures Modernization Act’s provisions.
Posted by: SocraticGadfly | June 03, 2008 at 02:25 PM