How is the blame to be apportioned?

In an earlier entry in which I posted Ann Coulter’s article, I wrote:

Unsurprisingly, [Coulter], like Mark Levin, blames the crisis 100 percent on the liberals. From what I’ve read so far, I’d say the true share of liberal blame is somewhere between 51 percent and 80 percent.

That remark set off a discussion, which I originally posted in that entry, but have now moved into this new entry under its own title.

Robert B. writes:

You wrote; “I’d say the true share of liberal blame is somewhere between 51 percent and 80 percent”

I agree with that. I remember sometime between 2002 and 2004 that the Bush administration was pushing loans for illegal Hispanics—Roy Beck could probably verify this, as I believe he and Vdare reported on it. The idea was, was that it would be harder to kick them out of the U.S. if they were property owners. How many dollars in the sub-prime mess are directly owed to this I cannot say.

James W. writes:

Your estimate of liberal culpability of 51 to 80 percent is wildly inaccurate. Liberal culpability is 100 percent, with Republican responsibility at 50 percent, for the new total of 150 percent. Yes, let us attempt to use government accounting in dealing with accounting for government.

The party with a heart proposed it was unfair that people who had less interest in staying sober, getting out of bed early, or delaying gratification (through no fault of their own) did not own homes at the same rate others did.

Against this impulsive humanitarianism Republicans contributed their 50 percent through silence, which among humans is generally taken to mean assent.

LA replies:

The 51 percent low end estimate is probably too conservative. I should have made it 60 percent. My point is that I don’t want to get on a partisan bandwagon in which the whole thing is blamed on liberals and we stop trying to understand the problem in a comprehensive way.

Stewart W. writes:

You said: “I don’t want to get on a partisan bandwagon in which the whole thing is blamed on liberals and we stop trying to understand the problem in a comprehensive way.”

Fair enough, but given that 98 percent of the conservatives in this country are in fact liberal in their core beliefs, it’s hard not to pin almost all of this on liberals. My colleagues in senior management are almost all smart, rich, financially savvy Republicans, yet to a man they would reflexively dismiss the Affirmative Action roots of this problem as non-existent or irrelevant.

The “conservatives” who permitted this problem to metastasize and fueled the disaster with a desire to turn a profit only did so because they were blinded by their own core liberal assumptions.

Perhaps “liberals” are to blame for 60-80 percent of the crisis, but liberalism bears total responsibility.

LA replies:

This is a fair argument. My first reply is that I’m not speaking here of “liberals” in the VFR sense that virtually all modern Western people are liberals. I’m referring to the particular left-liberal agenda of attacking banks as racist and pushing mortgages for minorities. By non-liberals in this context, I simply mean the financial institutions which according to the left are the sole cause of the crisis through their “predatory” and “greedy” practices. I’ve read, and posted at VFR, a bunch of powerful articles laying the cause at the feet of the left. I think the arguments presented in these articles are true. But it also seems to be the case that the investment houses greatly exacerbated the situation through their construction of these bizarre mortage-based securities, in which mortgage payments from low-level, poor-credit mortgagees including welfare types and illegal aliens were made the basis of investment bonds. From my neophyte’s knowledge of the stock market, it’s just one of the strangest and most unreal things I’ve ever heard of.

Now, one could say that the highly risky nature of the bad mortgages into which the left and the government forced the brokerage houses made such devices necessary in order to lessen and distribute the risk. But were they absolutely necessary? Did the institutions really have no choice in the matter? These are things I don’t know. I’ve yet to see an article that ties together the racial-egalitarianism analysis with the reckless greed analysis. And that’s why I am not ready to put the whole blame on the left.

At the same time, you are making a more subtle argument, that the money men went along with these mortgages, and even increased them and built a huge structure out of them, because as liberals they themselves could not see what was wrong with them. In this view, their destructive financial practices were the combined result of their underlying philosophical liberalism and of their reckless irresponsible greed.

Stewart replies:

“In this view, their destructive financial practices were the combined result of their underlying philosophical liberalism and of their reckless irresponsible greed.”

Yes, that is exactly the point. I too have not seen an analysis that combines these two ideas, nor do I really expect to see such a view outside of this website.

I suppose that is the cross you bear.

LA replies:

Yes. The money men’s liberal side was cool with extending subprime mortgages for the sake of equalizing racial outcomes in America. The money men’s reckless greedy side was cool with using these inherently unsound subprime mortgages (which, let us remember, were destined instantly to turn toxic the moment that housing prices ceased rising) as the basis for surrealistic investment bonds through which to make more money.

So the real truth of the matter is that the liberal egalitarianism and the reckless greed were two sides of a single phenomenon, the rejection of limits on human desire. I discussed this idea at length in my essay booklet “Erasing America” in 2003. (“Erasing America” will soon be made available online.)

Peter H. writes:

You write: “But it also seems to be the case that the investment houses greatly exacerbated the situation through their construction of these bizarre mortgage-based securities, in which mortgage payments from low-level, poor-credit mortgagees including welfare types and illegal aliens were made the basis of investment bonds. From my neophyte’s knowledge of the stock market, it’s just one of the strangest and most unreal things I’ve ever heard of.”

Yes, but remember that the MBS sold by Fannie and Freddie were implicitly guaranteed by the federal government, almost making them no-lose propositions for investors, this at the insistence, primarily, of congressional Democrats (Dodd, Frank, etc.). Additionally, Democrats, Obama in particular, were the primary beneficiaries of campaign contributions from Fannie and Freddie and tenaciously guarded those firms’ opaque business practices.

LA replies:

This is yet a further twist I hadn’t really taken this in yet. How can a quasi-governmental, government-backed entity give campaign contributions?

You write:

“Yes, but remember that the MBS sold by Fannie and Freddie were implicitly guaranteed by the federal government, almost making them no-lose propositions for investors, this at the insistence, primarily, of congressional Democrats (Dodd, Frank, etc.).”

What is the point of this, in terms of this discussion?

Peter H. replies:

Only that, from the point of view of the investors, these were not risky investments. They knew they had the backing of the federal government. They almost couldn’t lose. The Government said “We want more minorities and poor people to have houses, but we know their default rate will be much higher, so here’s what we’ll do. We’ll guarantee those loans so there’s no risk to you guys (Fannie and Freddie). By the way, I’m up for re-election next year.” These terms were put in place by congressional Democrats, so I think their responsibility for this crisis is closer to the 80 percent end of your estimation. I don’t think it is due so much to the “greed” of investors and their willingness to invest in “risky” ventures, which these were not considered to be (although they were risky for taxpayers). Rather, I see this as another so-called “transfer of wealth,” where easy credit (and, therefore, the ability to buy houses they couldn’t afford) went to minorities and the poor, all for the buying of votes and earning of campaign contributions.

LA replies:

Ok, Let me lay this out and you tell me if I have this right. Some of my questions may sound foolish, but I’m coming from a beginner’s level of knowledge in trying to understand these things.

1. Fannie issued subprime mortgages that were backed by the federal government. Meaning, that if a mortgagee defaulted, the government would pay Fannie.

Question; What amount? Let’s say the mortgagee defaults after paying $50,000 of a $300,000 mortgage. Does the government pay Fannie $250,000?

But why? Fannie, the mortgagor, owns the house. If the homeowner defaults, the mortgagor takes possession of the house. Isn’t that sufficient security? Is the mortgagor to get both the house and the unpaid amount on the mortgage?

2. Fannie bundles a bunch of subprime mortgages into a group of MBS’s and sells them to third-party investors. The TPI’s don’t feel this is a risk, because the original mortgage is backed by the government.

Meaning that if the mortgagees default, the TPI’s get the unpaid amount of the mortgage from the government? But if that’s the case, why didn’t the government simply start sending money to TPI’s such as Lehman when they began to fail? Why is a bailout being discussed now? Since Fannie and Freddie issued the great bulk of the subprime mortgages, and the federal government backed these mortgages, wouldn’t the government backing of the mortgages already be the backup system (as destructive as it would be) that would have been triggered when everything started to fail?

John B. writes:

You write:

I’ve yet to see an article that ties together the racial-egalitarianism analysis with the reckless greed analysis.

I’m rarely inclined to say this—but I think you’re missing the point. Put aside the notion of “reckless” greed. There was nothing reckless about it. That’s the point. [LA replies: I’m a beginner trying to figure these things out. Don’t be shy about correcting me.]

Keep your eye on Coulter’s statement:

In Bush’s first year in office, the White House chief economist, N. Gregory Mankiw, warned that the government’s “implicit subsidy” of Fannie Mae and Freddie Mac, combined with loans to unqualified borrowers, was creating a huge risk for the entire financial system.

The problem is right there: the “implicit subsidy.” See (as I’ve mentioned to you in a previous message) Wikipedia’s Fannie Mae article:

There is a wide belief that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA “implicitly taxpayer-backed agencies.”[12] The Economist has referred to “[t]he implicit government guarantee”[13] of FHLMC and FNMA. In testimony before the House and Senate Banking Committee in 2004, Alan Greenspan expressed the belief that Fannie Mae’s (weak) financial position was the result of markets believing that the U.S. Government would never allow Fannie Mae (or Freddie Mac) to fail.[14]

Quit looking at the mathematically-complex instruments by which the fundamental risk of these loans was supposedly mitigated—actually only disguised. I personally am not yet even clear where such instruments were spawned—whether in the quasi-governmental entities Fannie Mae and Freddie Mac or in the commercial institutions—but it doesn’t matter. What matters is that the government said, in effect, “Just give whites’ capital away; we’re good for it.”

What would you expect a banker to do? The public schools are socialism, and I object to their very existence. That doesn’t mean I wouldn’t attend one. Government-provided savings-deposit insurance is socialist, and I object to that, too. That doesn’t mean I would not take its supposed levels of insurance into consideration in deciding how much money to place in one bank or another.

That’s the whole problem with socialism—a term to which I object, but that’s another story. It puts everyone’s capital at the disposal of everyone else. What is one supposed to do? Is one supposed to say, “Oh, I object to Unemployment Insurance—so I’m not going to go and collect mine”? That’s certainly not what I said the time I qualified for it, and I should have felt foolish if it had been.

I have to say, too, that my own mentality is not that of Spencer Warren, who writes:

I am always suspicious of explanations of complex matters that give only one cause (as the fool Mark Levin always does).

I personally am always suspicious of the opposite, as, I’m happy to say, was Albert Einstein (who must rank at least as high as Mark Levin). The tremendous construct that is the Theory of Relativity arises from a single observation, which lay before mankind for two hundred years before Einstein recognized its implications: “The speed of light is a constant.”

This financial disaster has resulted 100% from the federal government’s socialization of mortgages. Eliminate, in your mind, the laws and regulations of which that socialization was composed—and then try to convince yourself that, in the absence of them, this would have happened.

Look also at the closing sentence of Peter Brimelow’s 1993 article—written as this monstrous violation of property was getting underway:

It is time conservatives stopped piously chanting about capital-gains tax cuts and woke up to the fact that their capital is under attack.

And what is the reaction of the Democrats as the nation is staggered by the consequences of their disgraceful conduct? To continue it:

Democrats are pushing to allow bankruptcy judges to rewrite mortgages to ease the burden on consumers who are facing foreclosure as part of the plan.

John B. writes:

Thanks for saying I needn’t have been shy about this.

I, too, am a beginner trying to figure this out—and I presumed to send you the somewhat long comment only because I thought it gave a pretty-comprehensive view of the matter. I give you much credit for organizing the messages of your various correspondents into what are, in effect, discussions among all of them and you. I’m sure it is not easy to do—particularly as quickly as you do it; but it makes VFR quite unlike anything else.

A reader sends the following excerpt from an article in the September 30, 1999 New York Times:

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates—anywhere from three to four percentage points higher than conventional loans.

Peter H. writes:

I’m a beginner, too, so I’m probably in over my head, but:

1. Apparently money from Fannie and Freddie did go to congressmen who, for whatever reason, did not allow light to be shown on these agencies.

2. This Ponzi scheme (i.e. people buying houses they couldn’t afford with the help of Fannie and Freddie, guaranteed by the federal government) worked until home values started to fall, and the house the government owned, after any particular default, was worth far less than the money they had originally provided the mortgagee to buy the house, said situation multiplied by thousands.

3. As to the questions in your final paragraph, my understanding is that nobody yet knows how much all of this will eventually cost, or what the ultimate value of the assets the government will then own will be. I’m not sure if any money has yet been paid out by the government, but, in any event, I would assume it’s just shuffling money between agencies from the perspective of the taxpayer.

There’s been great discussion of this by an apparently knowledgeable local talk radio host here in Minneapolis named Jason Lewis. He has filled in for Rush Limbaugh several times, but I think he’s much better than Rush. Anyway, I’m sure he will be discussing it on his show tonight at between 4 and 7 PM central time (5-8 PM eastern) and can be heard online.

Ben W. writes:

I was flabbergasted to read the following:

“At the center of this crisis are Fannie Mae and Freddie Mac. Although they didn’t intend to encourage this spiraling chain reaction, it was leading Democrats in Congress—Senate banking chairman Chris Dodd and his long-time counterpart in the House, Barney Frank—who supported legislation that ultimately led to more and more of these bad loans we are all stuck with.”

By a conservative commentator? No, a CNN reporter. So even liberals are beginning to see the roots of this crisis.

Doug E. writes:

You may find this post over at Hot Air of interest:

A great example of how we got to the credit-market meltdown posted at 5:00 p.m. on September 25, 2008 by Ed Morrissey

Daniel H. writes:

Conservative commentators are focusing almost solely on the role of Freddie/Fannie, but nobody forced all those investment banks and commercial banks also to underwrite and trade these MBS and CDO securities. If the problem only involved Freddie/Fannie the commentators would be in a good position to say, “There, see what socialism and racial politicking get you,” and they could toast each other and laugh as Dodd, Frank and the other boosters of Freddie/Fannie twisted. But that isn’t the case. Would it be that the problem is confined solely to Fannie/Freddie.

Merrill, Lehman, Bear, et al underwrote far more MBS and CDOs than the investor market could bear. That is why they had so much in inventory. And they did it with borrowed money. The thinking was that they could make a tiny guaranteed profit on each multiple of firm capital applied to MBS and CDO assets. Since they figured that the profit was almost guaranteed, why not leverage themselves 30-40 times firm capital. Now why would they think that this profit was guaranteed? Because they really did believe that they were smart enough to have figured out and hedged away all contingent risk. They really did. When the market froze up they were left holding these now illiquid securities. The market froze up because almost all the players were pursuing the exact same strategy. Now everybody needs to sell and nobody wants to buy. Morons. Greed and hubris destroyed the independent investment banks. Nothing else. They didn’t have to buy those mortgages from originators, they could have said, “Whoa, this market is too hot, I’ll take a pass,” but they didn’t, blinded by zeal for ever more profits and resultant bonuses for themselves. If the investment banks had declined to buy loans, originators would have stopped granting them to borrowers.

So, let’s put the requisite blame on Fannie/Freddie, their boosters and enablers, but let’s also not let Wall Street off the hook. That’s why I am perfectly comfortable with the proposals that cap executive pay of these reckless, near criminal, institutions.

David B. writes:

So-called conservatives support things like increased loans for minorities in order to show what good racial liberals they are.

Peter H. writes:

Although this is a very complicated subject (for me), why can no one briefly and cogently explain its essence? Why have I had to look far and wide for answers? Many details have been brought out in this and other of your threads (for which I’m thankful) and in some “conservative” media outlets, and yet the origins of the crisis seem to remain obscure. I believe that, in the end, it arose not as a result of “greed,” outrageous CEO compensation, or other capitalist bogey men, but of Fannie and Freddie and classical political patronage. This is the true heart of the matter on which our eyes should be affixed, and I think it’s an abomination.

La replies:

The problem is, the subject is so complicated, the history of this went through so many stages, with so many different laws involved, that each article, even when it comes from the same basic point of view as other articles, will emphasize some bits of this history and ignore others, which becomes confusing. Thus some articles emphasize the Community Redevelopment Act of 1977, others emphasize the guidelines issued by the Boston Fed in 1992, others emphasize a law passed by Congress in 1995 (I forget its name), others emphasize the Democrats’ rejection of proposed regulation of Fannie and Freddie in 2005. And each article says that THIS was the cause of the crisis. So it becomes very difficult to form a stable, coherent picture of what happened. everyone, including each expert, has his own picture of it. We have to form our own picture out of the partial pictures we’re given.

Then there is the difficulty of the basic concepts involved in this topic. I’ve seen that as soon as you look at any particular statement, e.g., “third party investors purchased mortgage backed securities,” or “as part of the bailout, the government will purchase the mortgage backed securities,” and try to get at its concrete meaning, you enter a world of bewildering abstractions that only a specialist can understand. This is because we’re not dealing with concrete things here but with debt buying debt backed by debt. It’s all unreal from the ordinary point of view. It’s not a three dimensional or even four-dimensional world, it’s more like a five- or six-dimensional world.

Even the simplest transaction becomes bewildering when you really try to understand it in the sense of “A is connected to B is connected to C.” At least it has been so for me.

For example, a few days ago I thought I had understood that Lehman Brothers had gotten into trouble by buying MBS’s, then the mortgagees stopped paying, so Lehman didn’t have the money on hand to pay the entities it had borrowed from to purchase the MBS. I remember reading that Lehman had something like $1.3 billion on hand, and $4.5 billion it had to pay, so it couldn’t maintain its existence. I felt satisfied that I had understood this one little piece of the picture. But then a couple of days later I spoke to a friend who understands the stock market, and he explained to me that Lehman hadn’t exactly borrowed money to purchase the MBS, because it hadn’t paid any money (beyond maybe 10 percent on margin) for the MBS. So if it had only paid a tiny percentage of the value of the MBS to purchase the MBS, Lehman didn’t owe money to anyone in the usual sense of the word, but, rather, when the mortgagees defaulted and money stopped coming in and the value of the MBS declined, Lehman had to pay the entity from which it had purchased the MBS on margin.

To understand this better, we considered the simple example of a stock purchase on margin. Then I asked him, “If I am buying the stock on margin and am only paying the seller 50 percent of the value of the stock, in the expectation that an ever-rising stock price will make it unnecessary for me ever to pay the whole amount, how is the seller getting paid for the stock he’s selling to me?” And my friend admitted he was stumped by that, too.

So if even the simplest level of a stock transaction involves such unfamiliar concepts and is so hard to grasp, imagine how difficult it is to grasp things like mortages bundled into mortgage backed securities, with each of the securities divided into tranches, each tranch with a different credit rating, and with layer upon layer of these abstract, complex entities and purchases piled on top of each other.

So this is a tough area, not involving ordinary concepts.

In any case, when I come across an article that has a overall view of the problem, even if the overall view is different from the overall view in other articles, I post it. The hope is that we will get closer and closer to a coherent view of things.

September 26

LA writes:

Here is Wikipedia’s description of buying on margin:

Margin buying is buying securities with cash borrowed from a broker, using other securities as collateral. This has the effect of magnifying any profit or loss made on the securities. The securities serve as collateral for the loan. The net value, i.e. the difference between the value of the securities and the loan, is initially equal to the amount of one’s own cash used. This difference has to stay above a minimum margin requirement. This is to protect the broker against a fall in the value of the securities to the point that they no longer cover the loan.

Here is a passage from an article by Christopher Ruddy at Newsmax in which he appears to give two different and contradictory pictures of how an investment firm purchases the MBS:

But many Wall Street firms, hedge funds and other investments took incredible, unwarranted risks using these securities. These firms would borrow money at low rates—say 4 percent—and invest in CDOs paying 6 to 7 percent. This small difference in rates of 2 to 3 percent, the arbitrage, would throw off enormous returns, especially considering little or no money had been placed on the table to buy the securities.

I have been told that Lehman and AIG played this leveraging game, investing only $1 for every $30 they held in such toxic suggestions. Again, what they did was not a crime. They took enormous risk and reaped huge returns—for a while.

In the first paragraph, it sounds as though the firm borrowed the full amount on each MBS it purchased and is paying off the creditor at four percent per year.

In the second paragraph, the firm has purchased the MBS on margin, at one 30th of the value of the MBS. The entity from which the firm borrowed the money, presumably the firm’s broker (?), paid the full amount to the seller of the MBS, and the MBS is the collateral on that loan. The loan is not paid off at a yearly interest, as in a normal loan, but rather is repaid when the firm sells the MBS at a higher amount than the amount for which it purchased it. So for example if the MBS was worth $100, the firm paid $3.33 and owes its broker 96.67. Let’s say the firm then sells the MBS for $150. It receives $150, pays its broker $96.67, and pockets $53.33. It has made a profit of $50 by only putting down $3.33.

But if the MBS has dropped in value instead of increased, then the firm gets a “margin call” from its broker and has to pay it a certain amount of money immediately. That’s when many purchasers of securities on margin go bankrupt and leap out of windows.

My point here is that Ruddy is giving these two totally different descriptions of how the firm purchased the MBS. In the first description, the firm makes a profit from the difference between the rate at which it is paying the loan it took to purchase the MBS, and the amount of interest it is receiving from the MBS. In the second description, the firm makes a profit from buying the MBS on margin, and then later selling the MBS at a higher price than the price for which it purchased it. These two arrangements are in different universes, yet Ruddy presents them as though they were the same arrangement.

And what I’ve just described is the kindergarten level of the issues we’re dealing with here. When there’s this much confusion on the kindergarten level, that gives an idea of how difficultit is to understand the higher level issues.


Posted by Lawrence Auster at September 25, 2008 03:36 PM | Send

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