Libertarian Leanings

To Tax and Regulate

Paul Krugman is very weird or very dishonest, or maybe both.  Here is his latest, rather novel solution for... something:  Professor Krugman would like to tax financial transactions, even while admitting that it would not solve much. 

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 Gorton and Metric abstract (link to the abstract courtesy of Tom Maguire) is where we find this:

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 foreclosure.

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.

Foreclosure Stats

According to liberal wisdom, unbridled capitalism is largely to blame for the current foreclosure mess.  It was those subprime lenders.  First, they made so many "liar loans," loans where lenders never bothered to do any income verification.  On top of that, those unscrupulous subprime lenders supposedly misled borrowers into taking out adjustable rate mortgages that they would never be able to afford when monthly payments inevitably went up.  

Not so, says Stan Liebowitz, professor of economics at the University of Texas.

'But the focus on subprimes ignores the widely available industry facts (reported by the Mortgage Bankers Association) that 51% of all foreclosed homes had prime loans, not subprime, and that the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures. (These percentages are based on the period since the steep ascent in foreclosures began -  the third quarter of 2006 -- during which more than 4.3 million homes went into foreclosure.)

[...[

What about upward resets in mortgage interest rates? I found that interest rate resets did not measurably increase foreclosures until the reset was greater than four percentage points. Only 8% of foreclosures had an interest rate increase of that much. Thus the overall impact of upward interest rate resets is much smaller than the impact from equity.'

The most important factor was the amount of homeowner equity in the house.  In other words, if forced to sell would the homeowner get enough from the sale of the house to pay off the existing mortgage.  When the answer is no, foreclosure is a likely result. 

How many homeowners have been forced to sell because they lost their jobs?  The solution to the foreclosure crisis is strong economic growth and job creation.  Unfortunately, the Obama administration has chosen to pursue policies aimed at income redistribution rather than economic growth.

The Buffett solution

It's worth a listen, although according to the Wall Street Journal, much of the reporting on Warren Buffett's comments has failed to pick up on it.  Here's the plan.

'In fact, the nationalization of Fannie and Freddie is water over the dam. The men's perspective may be one of pain, but it is historical pain.

Now comes Warren Buffett, a big investor in Wells Fargo, M&T Bank and several other banks, who, during his marathon appearance on CNBC Monday, clearly called for suspension of mark-to-market accounting for regulatory capital purposes.

We add the italics for the benefit of a House hearing tomorrow on this very issue. Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It's not so fine for regulatory purposes. It doesn't just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.

What happens next is exactly what we've seen: Their share prices collapse; government feels obliged to inject taxpayer capital into banks simply to achieve an accounting effect, so banks can meet capital adequacy rules set by, um, government.

(This sounds silly, but has been a big part of government's response so far.)

CNBC, sadly, has been playing a loop of Mr. Buffett's remarks that does a consummate job of leaving out his most important point. Nobody cares about the merits of mark-to-market in the abstract, but how it impacts our current banking crisis. And his exact words were that it is "gasoline on the fire in terms of financial institutions."

Depressing bank stocks today, he said, is precisely the question of whether banks will be "forced to sell stock at ridiculously low prices" to meet the capital adequacy rules.

"If they don't have to sell stock at distressed prices, I think a number of them will do very, very well."

He also proposed a fix, which CNBC duly omitted from its loop, namely to "not have the regulators say, 'We're going to force you to put a lot more capital in based on these mark-to-market figures.'"'

In the overnight lending arena which is where the credit freeze was said to have begun, mark to market accounting would presumably still be in effect.  Thus a lender's credit department would still be able to accurately assess the credit worthiness of borrowers.  But with the suspension of mark to market accounting for regulatory purposes, regulators would have no grounds for forcing banks to raise capital, which implies that the government would have less reason for pumping in money to capitalize banks.

Buffet is not alone in his thinking.  Econlog has a very good analysis of the mark to market rules by economist Jeff Hummel. 

'Economists now realize that reserve requirements, designed to make banks more LIQUID, have the unintended reverse impact during a panic, tying up cash that banks need to pay out in order to stem the panic. As a result, reserve requirements are fast disappearing as a tool of bank regulation. Similarly, capital requirements, designed to make banks more SOLVENT, also have the reverse impact during a crisis. What follows is Less's analysis:

"Any discussion of mark-to-market accounting must differentiate between the beneficial effects of honestly reporting assets at what they are actually worth and the destructive impact of inflexible regulations that utilize the principle. Current discussions have blurred the distinction.'

The House Financial Services Committee will hold hearings tomorrow.

'Washington, DC – Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, today announced that the Subcommittee will hold a hearing to examine the mark-to-market accounting rules that many contend have exacerbated the current troubles in the financial industry and in the broader economy. The standard requires companies to value assets they hold at current market values. For assets that are frozen and have a diminished current market value but may recover value in the future, the standard has proven problematic. Companies are then forced to write-down billions in assets, which can lead to further write-downs elsewhere.

“Illiquid markets have resulted in great difficulty in valuing sizable assets.  Some have therefore complained about fair value accounting and sought to eliminate it.  While companies need stability, investors still need accurate information.  We therefore cannot allow for fantasy accounting that wishes away bad assets by merely concealing them,” said Chairman Kanjorski.  “As a result, we will seek at this hearing to engage in a constructive, thoughtful conversation with a diverse range of viewpoints aimed at identifying fair-minded, incremental, and achievable fixes to this problem.  In short, I want to find a way – within the existing independent standard-setting structure – to still provide investors with the information needed to make effective decisions without continuing to impose undue burdens on financial institutions.  Each of our anticipated witnesses will have the opportunity to contribute as we all pursue consensus solutions together to this thorny, contentious issue.”'

In other times I might dredge up some miniscule hope that a solution will be forthcoming.  The Committee is chaired by Barney Frank, Democrat from Massachusetts.  Democrats complain that our current crisis is the result of laissez faire capitalism.  Those in favor of a suspension of mark to market rules see it as a consequence of regulation.  Chances that the Committee will recommend easing regulations seem prettly slim, since the opportunity to take over the economy stands before them.  Why spoil it by fixing the problem?  After all, that would be letting a good crisis go to waste.

It's about time - but will there be payback?

The threat to the American business climate posed by a Democratic sweep in this year's election has finally aroused survival instincts in U.S. Chamber of Commerce members.  So writes Kimberly Strassel.  The organization has historically been non-partisan, but with so much at stake this year it has finally joined the fight with its own ad campaign.

It also unveiled the season's most humorous ad, entitled "Meet Bill." It features real-life union boss, Bill, caught assaulting a cameraman ("I'm gonna' take this camera and stick it somewhere you don't want it!"). It points out that it would be Bill who, under card check, would get to monitor votes in a union drive.

This is brave stuff, especially given Democratic admiration for Bill-like tactics. Chuck Schumer, who is leading the Senate effort to turn Democrats into masters of the universe, is livid. All the more so, given he's spent the past year threatening the business community with dire retribution if it doesn't support his party. (Weren't they listening?) He recently ripped the group as nothing more than a "wing" of the GOP, and has made clear he'll remember the slights.

Apparently the Chamber's historically non-partisan stance is maintained in hopes of avoiding the kind of political retribution Senator Schumer is said to have threatened.  Could it be that their their fears were well founded? 

An important angle in the IndyMac failure that may get lost in ominous headlines tonight and tomorrow: federal regulators pointedly cited U.S. Sen. Charles Schumer, D-N.Y., in explaining the bank's failure. In simple language, federal regulators blamed Schumer for a run on the bank.

Here's from the press release issued by IndyMac's regulator, the Office of Thrift Supervision: "The OTS has determined that the current institution, IndyMac Bank, is unlikely to be able to meet continued depositors’ demands in the normal course of business and is therefore in an unsafe and unsound condition. The immediate cause of the closing was a deposit run that began and continued after the public release of a June 26 letter to the OTS and the FDIC from Senator Charles Schumer of New York. The letter expressed concerns about IndyMac’s viability. In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts."

Was it payback the led to the release of Schumer's letter of alarm?  Who at IndyMac might have gotten on the wrong side of Senator Chuck?  (Boldface in the original above, and the link doesn't work.)

The McCain letter

During the second presidential debate at Belmont University in Nashville, Tennessee, Barack Obama repeated the charge that deregulation was the cause of the credit crisis that has triggered the global economic meltdown.  He said,

"Sen. McCain, as recently as March, bragged about the fact that he is a deregulator. On the other hand, two years ago, I said that we've got a sub-prime lending crisis that has to be dealt with.

I wrote to Secretary Paulson, I wrote to Federal Reserve Chairman [Ben] Bernanke, and told them this is something we have to deal with, and nobody did anything about it.

A year ago, I went to Wall Street and said we've got to reregulate, and nothing happened.

And Sen. McCain during that period said that we should keep on deregulating because that's how the free enterprise system works."

Contrary to Obama's charge, Senator McCain and nineteen other senators urged the Senate Majority Leader, Bill Frist, and Senate Banking Committee Chairman Richard Shelby to take up legislation, not to deregulate, but instead to provide stricter oversight of Fannie Mae and Freddie Mac.  An image of that letter follows.

According to Obama's Senate webpage, Senator Obama did in fact write a letter to Paulson and Bernanke as he claimed.  But the import of Obama's letter was to urge them to convene a summit.  Said Obama, "The summit should consider best practice loan marketing, underwriting, and origination practices consistent with the recent (and overdue) regulators’ Proposed Statement on Subprime Mortgage Lending. The summit participants should also evaluate options for independent loan counseling, voluntary loan restructuring, limited forbearance, and other possible workout strategies." Obama complained at the debate that he wrote his letter but nobody did anything about it.  "Nobody" includes Obama.  By writing his letter he was essentially jumping on an already moving band wagon.   On top of that, he wrote his letter nearly a year after the McCain letter urged legislative action.  Unlike Obama's letter, the McCain letter resulted in action.  Unfortunately, Democrats were the ones who geared up for action, and once again they blocked improvements to oversight of Fannie Mae and Freddie Mac. Update:  New Hampshire residents, please note that John Sununu was one of the nineteen other senators who recognized the risk posed by Fannie and Freddie.