First on the Financial crisis
As the foundations of this crisis were laid, there were always arguments against massive regulatory intervention to deal with it. Those arguments always sounded convincing. The stayed convincing even as the situation transformed itself from a justified boom in long duration assets driven by advances in diversification and by capital inflows pushing down interest rates, to froth, to irrational exuberance, to a full-fledged bubble.
The first argument was: "well it is their money." Countrywide probably knows what it is doing. There are major benefits from diversification and better access to credit. Even if it does not know what it is doing, it isn't the government's job to rescue the investors in Countrywide from the fact their risk controls are not what they ought to be.
Second, Alan Greenspan really is a Randite, really is a follower of Ayn Rand. He really does believe that it is a bad thing to infringe your freedom and protect you from yourself. He really is the kind of person who thinks that it is bad for you if the government keeps you from making stupid investments that cost you all your money. You can ask him--"do you think there should guardrails on the ledge of the Grand Canyon?"--and he might well say no--that there should be warnings, but if grown-ups wish to venture too close to the crumbling edge... they are grown ups, and should not be treated like children.
The third argument was: "who is going to get hurt?" Investors in Countrywide, but they are rich and risk-loving and if they want to build the rest of us houses we should probably say "thank you." And somebody buying a house east of Riverside California with a zero-down, a teaser rate, a pick-what-you-pay mortgage--what they are really doing from an asset-price perspective is renting a house at a below-market rent for three years and being given a free call option on the house. They will be sad if the house price doesn't go up and the call option is not worth exercising. But that is regret. That is not harm: they did still get to live in the house at a low rent for three years. So why should the government step in and keep people from getting these deals if Countrywide wants to provide them?
Fourth, and most important, it is a big political looser for regulators to go before Congress. The Democratic members would whack them: why aren’t
you letting my constituents buy the houses they want to buy? The Republican members would whack them: why aren’t you letting my contributors make the loans they want to make?" That’s a very unpleasant position for a regulator to be in--when both Republicans and Democrats agree that you are an ass.
Fifth, there was the fact that the old framework for lending locked lots of people out of the real estate asset class, and a belief that we should be experimenting with new ways to get money to people who want it to make investments--that we should be trying to broaden the access of the poorer half of Americans to high-return investment vehicles.
Most important, however, was the overall belief on the part of the regulators that they could handle it. Subprime was a small asset class in the global economy. The Federal Reserve was powerful. Whatever stupid things financial markets did, the Federal Reserve could clean up the mess afterwards and build firewalls between finance and the real economy so that we would not suffer from high unemployment and a deep recession. The Federal Reserve had handled it in 1987 with the stock market's Black Monday, had handled it in 1991 with the Savings and Loan crisis, had handled it 1995 with the Mexican crisis, in 1997 with Malaysian crisis, in 1998 with the triple crisis--the Korean crisis, the state bankruptcy of Russia as it became clear that just because you were a nuclear armed ex
superpower that did not mean the IMF thought you were too big to fail. the bankruptcy of the largest hedge fund in the world, LTCM. We had the 2001 collapse of the dot-com bubble. And in every single case we managed to handle it: contain systemic risk, stabilize the financial system, and avoid a deep recession.
And on the long run deficit problem
It is a fact that if congress simply goes home--doesn’t do anything for the next 10 years except keep the federal government on autopilot, or if it does do things if it pays for whatever increases in spending it enacts by raising taxes and pays for whatever tax cuts it enacts by cutting spending--that we do not have a long run deficit problem. If congress goes home for ten years our program spending is matched to our tax
revenues, which means a declining debt burden because the growth rate of the economy is larger than the interest rate on our debt.
Our belief that we have a long-run deficit problem is based upon the belief that congress will pass laws that increase spending and that cut taxes--that it will repeal the Independent Payment Authorization Board's authority to try to make Medicare more efficient, that it will repeal the Affordable Care Act's tax on high-cost health plans. Given that the fear is based on a belief that some future congress will bust the budget, it is hard to see how we can address this fear through any possible piece of legislation today--for no congress can bind its successors.
This is a problem.
tnb
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