Would a Tobin tax solve all our problems? Of course not. But it could be part of the process of shrinking our bloated financial sector. On this, as on other issues, the Obama administration needs to free its mind from Wall Street’s thrall.
A better question for the professor to pose, would a Tobin tax solve any problem? Apparently, only if you believe "our bloated financial sector" needs shrinking. I'm not where I think any of our sectors, aside from government, need shrinking, and most certainly not our financial sector.
Besides, I thought Fanny and Freddie took care of our bloated financial sector by flooding the residential housing market market with easy money and bloating that market. The implosion of that bubble didn't just cause a drop in housing prices. As Krugman points out, "Losses in subprime and other assets triggered a banking crisis..." The banking crisis to which the professor refers took a big enough chunk out of our financial sector to suit me. Krugman, however, doesn't even nod in that direction. He offers nothing to address the subprime and other asset losses that were behind it all.
To determine the cause of those particular losses we should look to University of Texas economics professor, Stan Liebowitz.
New Evidence on the Foreclosure Crisis
Zero money down, not subprime loans, led to the mortgage meltdown.
By STAN LIEBOWITZ
What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected.
It also means that Nobel Laureate Krugman is misguided (or maybe just deceitful) in his focus on Wall Street as the problem in most need of a regulatory cure. Wall Street is, however, a place where taxes can be levied in a way that minimizes the political pain, so Krugman looks for an easy target. Financial transactions are in his cross hairs. Rather than address the cause of the underlying losses Professor Krugman would prefer to tinker with the system on the basis of Gordon and Metrick.
The Panic of 2007-2008 was a run on the sale and repurchase market (the “repo” market), which is a very large, short-term market that provides financing for a wide range of securitization activities and financial institutions. Repo transactions are collateralized, frequently with securitized bonds. We refer to the combination of securitization plus repo finance as “securitized banking”, and argue that these activities were at the nexus of the crisis. We use a novel data set that includes credit spreads for hundreds of securitized bonds to trace the path of crisis from subprime-housing related assets into markets that had no connection to housing. We find that changes in the “LIB-OIS” spread, a proxy for counterparty risk, was strongly correlated with changes in credit spreads and repo rates for securitized bonds. These changes implied higher uncertainty about bank solvency and lower values for repo collateral. [My emphasis]
Well yes, but it turns out the securitized bonds that were used as collateral were the ones that were said to be clogging up the credit markets -- mortgage backed securities in which the underlying mortgages were being foreclosed right and left. You might expect the high rate of foreclosures would have a negative impact on value of the bonds, and that might cause some angst on the part of those who might be holding them as collateral. Is it supposed to be a big surprise that interest rates are affected by risk? What to do?
Here's an unoriginal thought: We could change mortgage lending
regulations so that home buyers would bring a bigger down
payment to the table when they buy a house. This would do two things.
First it would put a tighter limit on the amount
of money going into the home buying market. Second, the higher down
payment would provide a cushion for the
buyer in the event of a fall in housing prices, reducing the chance of
If you protect the original mortgage investment you protect the mortgage backed securities.
But no. Professor Krugman wants to tax repo transactions. Apparently Krugman thinks repo transactions are "socially useless" activities, and so he would discourage them through taxation. Lefties are such moral busybodies, aren't they. Socially useless. It boggles the mind. But it doesn't fix anything. And here I thought lefties were all about getting to root causes, but I guess that's true only if the fix involves some intrusive government regulation or a tax.
Update: Peter J. Wallison, a senior fellow at the American Enterprise Institute, asks why AIG was bailed out, if it really wasn't too big to fail.
Since last September, the government's case for bailing out AIG has rested on the notion that the company was too big to fail. If AIG hadn't been rescued, the argument goes, its credit default swap (CDS) obligations would have caused huge losses to its counterparties—and thus provoked a financial collapse.
Last week's news that this was not in fact the motive for AIG's rescue has implications that go well beyond the Obama administration's efforts to regulate CDSs and other derivatives. It's one more example that the administration may be using the financial crisis as a pretext to extend Washington's control of the financial sector.
Nor was it true that the financial crisis was precipitated by the predatory lending practices of mortgage lenders. According to Mr. Wallison, it was government policies at the root of it.
No doubt some deceptive practices occurred in mortgage origination. But the facts suggest that the government's own housing policies—and not weak regulation—were the source of these bad loans.
The fact that the government itself either bought these bad loans or required them to be made shows that the most plausible explanation for the large number of subprime loans in our economy is not a lack of regulation at the mortgage origination level, but government-created demand for these loans.
On an optimistic note, the disclosure about credit default swaps and the AIG crisis may mean the push for greater regulation of the financial industry is running off the rails.