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In Summary
Posted by: Lance on Thursday, October 02, 2008

Tyler Cowen states his basic views on the crisis. My response in italics:


 
1. Glass-Steagall repeal was not a major cause of the financial crisis, nor was government-induced "minority lending."

I agree on the first, the second charge has some validity, but only in terms very different than the typical charge.

2. We should use regulation to move more of the currently unregulated derivatives markets to the clearinghouse model.

Bingo! Especially Credit Default Swaps.

3. The crisis represents a massive conjunction of both market and governmental failure.

Check.

4. I would not nationalize banks as ongoing concerns, at least not short of a far more extreme emergency than the current status quo.

Check.

5. The modified Paulson plan was better than nothing — especially after the market had been scared — but far from my first choice. In any case the plan would have been revised almost immediately. The Paulson and Dodd plans were never that far apart.

I disagree. No plan was better than the plan as advertised, though Michael has pointed out that it gives Paulson the opportunity to do some useful things.

6. My first choice is to induce and if need be to force more information revelation, identify the insolvent banks, close them up, and give the battle-tested FDIC a much greater role in the whole process.

This is the critical step, and we need to move as quickly as possible and begin a process of financial triage.

7. In the meantime the Fed should not worry much about inflation.

I agree. Deleveraging is inherently deflationary.

8. The critical deregulatory mistake was allowing excess leverage. Many deregulations get blamed but in fact contributed little to the problem.

I couldn't agree more.

9. Everyone says that letting Lehman die was a big mistake but I'm not yet convinced. Maybe a bracingly high TED spread is what we need.

I am with him here.

10. Libertarians are overrating the moral hazard argument, as many equity holders have been wiped out.

True as to past actions, but they are not overstating the moral hazard of buying the bad assets at a price that might actually add meaningful capital into these institutions.

11. If someone is pushing conclusions and not identifying the potential weak points in his or her arguments, be suspicious. Also beware of anyone pretending to offer you simple answers.

Who can argue with that? This crisis will not be solved, but worked through. We will be struggling with this for years, not months.

12. I have a long and complicated view on the relevance of Austrian Business Cycle Theory which resists easy summation, but markets could have and should have been more cautious in response to Greenspan's easy money policies.

Exactly. Whatever poor incentives were in place, whatever regulatory elements were lacking or unfortunately in place, that is no excuse for their behavior, their excess risk taking, the leverage employed or the dishonesty about their books.

13. Insolvent hedge funds and the commercial paper market remain outstanding issues which are not easy to address.

Insolvent hedge funds should die on the vine, the commercial paper market is a tough nut to crack.

14. I agree with Arnold Kling about relaxing capital requirements though at this point I don't expect it to help much.

Check.

15. The crisis is complex and has many causes; there won't be a simple or quick solution.

I agree. There is no solution, just trying to keep the ship from going down. We at best will be able to muddle through.
Arnold Kling responds to Tyler and adds several key elements which you will recognize from my comments:
In hindsight, I think that the crisis was caused by
a) creation of the secondary mortgage market (50 percent)
b) low down payment mortgages (30 percent)
c) the "suits vs. geeks" divide (15 percent)
d) other (5 percent)
Read his explanation of each. I can find no real complaint with them. I am going to highlight his suits vs. geeks divide. As someone on the geek side of this i admit to being biased:
My point about suits vs. geeks is that too many people did not understand the risk characteristics of these loans. I disagree with James K. Richards, who claims that the risk modelers got it wrong. The risk modelers told Richard Syron of Freddie Mac not to plunge into subprime lending with so little capital. The risk modelers at Goldman kept that firm from making the sorts of mistakes other companies made.

The decline in house prices was not a Black Swan. It was a highly plausible scenario. The problem is that the suits did not grasp the impact that such a decline would have on mortgage securities. The clueless suits include regulators, which explains why the crisis took them by surprise. It also explains why I do not trust them to come up with the best solution.

Decent, upstanding people say that we have to trust Ben Bernanke, Henry Paulson, Barney Frank, and other leaders. The public are considered rubes for not respecting the establishment. In this case, the public happens to be right. The suits are clueless.
I agree. These are smart people, but I don't believe they understand what they are dealing with. Unfortunately the people who do are not qualified to make policy or hold office. This is a very troubling issue.

Risks:
The economic ship faces a number of icebergs. Oil markets are taking wealth out of the country. House price declines are taking paper wealth away from ordinary families. On the horizon, there could be an adverse shift in the terms of trade. The number of hours that the average American has to work to earn enough to buy a bottle of French wine, a pair of Italian shoes, or a Chinese-manufactured product could (should?) be much higher than it is today.

In this context, the consolidation in the financial sector is a relatively minor issue. The only policy challenge is to keep banks functioning. There are many ways to do that which do not involve speculating in mortgage securities.
Dead on.

Housing:
We need housing units to be occupied, at whatever rent or price clears the market. We need owners to be legitimate, meaning people who can afford reasonable down payments and mortgage payments. Getting from here to there is not easy, but I suspect that the more government intervenes, the longer and more painful the process will be.
I share that suspicion. The government at best should encourage dissemination of workable solutions and getting rid of legal obstacles to people taking advantage of them.
I do not think that the private sector is blameless. I do not think that the public sector is blameless. I do think that lobbying and corruption are endemic in the mortgage securities business. We ought to be trying to let that cesspool gradually dry up, rather than throwing taxpayer money into it.

I find it unsettling that Congressional leaders would announce that they have a deal and then fail to pass a bill. It used to be that the definition of having a deal was having the votes to pass legislation. It didn't used to be a form of bluffing.

I find it unsettling that the establishment is promoting fears of another Depression. It used to be that worries about another Depression were confined to obscure books written by crackpots and lunatics. Today, the fear of a Depression is being promoted by the establishment, while those of us who are trying to remain calm and measured are treated as crackpots and lunatics.
My only disagreement is with the last statement. I have already discussed ways in which we are being frightened unnecessarily. I do believe that if not a depression, a severe and lengthy recession and sluggish growth for long afterward is a real possibility, if not probable.

It seems the three of us are not that far apart.

 
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