What Went Wrong - The Alan Blinder Version

Econ prof and former Fed Vice-Chairman Alan Blinder presents his list of six avoidable errors that led to the current financial morass.

Our capitalist system did not condemn us to this fate. Instead, it was largely a series of avoidable — yes, avoidable — human errors. Recognizing and understanding these errors will help us fix the system so that it doesn’tmalfunction so badly again. And we can do so without ending capitalism as we know it.

The intro includes this a gem:

My list of errors has six whoppers, in chronologically order.

Yes, I prefer to recount other people's errors in chronologically order too - it helps create that "We're all human and prone to error" feeling.  As to the list, Blinder picks these:

1.  Failure to regulate derivatives in 1998.  I think this fear is exaggerated.

2.  The decision in 2004 to allow investment banks to increase their leverage.  After the fact that obviously did not work well but it is not obvious that, going forward, we can always rely on prescient regulators to rein in foolish capitalists shrewdly and sensibly.  In fact, one can imagine times and places where adults with their own funds at risk might actually do a better job of evaluating risk and reward than would be done by a cadre of high-level civil servants.

3.   A Subprime Surge - geez, yet another surge opposed by libs.  Yet strangely, Congress and the President were pleased that folks with spotty emploment histories had access to that great middle-class wealth machine, the housing market.  Dare we mention that part of the political impetus for the subprime surge came from the fact that blacks and Hispanics were disproportionately aided by this credit bubble on the way up?  The Times so dared way back in 1999.  Hmm, Prof. Blinder never mentions FNMA at all - that's waht we call keeping the blinders on.

4.  Fiddling On Foreclosure - Binder thinks that earlier tinkering with the foreclosure mechanisms could have mitigated this.  I thik the horses had long since left the barn and were runing free.

5.  Letting Lehman Go:  Blider thinks that the confusing switch in the too big to fail doctrine to allow Lehman to perish sowed panic and confusin and was a terrible mistake.  I concur.

6.  TARP's Detour:  Over to Blinder:

The final major error is mismanagement of the Troubled Asset Relief Program, the $700 billion bailout fund. As I wrote here last month, decisions of Henry M. Paulson Jr., the former Treasury secretary, about using the TARP’s first $350 billion were an inconsistent mess. Instead of pursuing the TARP’s intended purposes, he used most of the funds to inject capital into banks — which he did poorly.

To illustrate what might have been, consider Fed programs to buy commercial paper and mortgage-backed securities. These facilities do roughly what TARP was supposed to do: buy troubled assets. And they have breathed some life into those moribund markets. The lesson for the new Treasury secretary is clear: use TARP money to buy troubled assets and to mitigate foreclosures.

Right - if the fireman had directed their efforts to the third floor instead of the fourth all would have been well.  Please - by October 2008 we were going to be in for a grim economic slowdown whether TARP was handled optimally or not.

I had some thoughts on this back when Joseph Stiglitz offered his "What Went Wrong" list.  I blame the rescue of Long Term Capital Management in 1998 for crystallizing the notion that every firm, even previously unheard-of hedge funds,was too big to fail.

Comments

[bad]

I have chronologically disorder myself.

[MayBee]

I'm surprised the Lehman people haven't done a little push back against Geithner.

[kim]

Where's TCO when we could use him? Don't tell me, I know; offending lucia.
=============================

[kim]

I'm still glad Lehman went. They were in the forefront of carbon manipulation schemes as well as having Gore and Hansen for advisers. Someone took a bath on their advice, and I hope their memory of water under the bridge is as long as the Mississippi.
==================================

[bad]

Why is Geithner the only one for Treasury? What does he have on whom?

[RichatUF]

2 and 3 on his list are inter-related, with a smaller sub-prime sector, more renters, fewer foreclosures.

I'm also not seeing how the mortgage market or finance generally in the period prior to the crisis was "laissez faire-y tales" seeing has how there are the FNs, Federal housing authority, OTS, FDIC, SEC, 50 sets of state laws regarding mortgages, federal bankruptcy law, state bankruptcy law, the Fed...and many, many more

I'm not seeing number 4 either. With the passage of the first housing rescue bill and this round of TARP funds, Congress seems to want to keep the market in limbo so properties sit vacant and decaying instead of letting the vultures in to feast. I would think that more foreclosures (and more auctions) not less would get the markets moving. Also, with Congressional tinker gnomes fine tuning the gears, all they are doing is making foreclosures more costly, increasing there number in the out months, and causing house prices to drop further because the market can't find equilibrium.

His howler about Barney Frank and Richard Clarke should probably pass without comment.

[RichatUF]

Maybee-

I'm surprised the Lehman people haven't done a little push back against Geithner.

A grand jury is investigating the Lehman collapse. Most of the senior executives have been roped to testify.

[RichatUF]

bad-

Why is Geithner the only one for Treasury? What does he have on whom?

Rick has more flair, but this little tool at the NY Fed could be a clue. I'll see if I can dig up the comment and link it, but if they have it down to the county level they have it at the Congressional district level. A tight, cozy relationship among Congressman, the realtors, the appraisers, ACORN, and the investment banks which packaged them.

[jimmyk]

His howler about Barney Frank and Richard Clarke should probably pass without comment.

Yes, not to mention his howler about free market ideology, as opposed to the ideology that everyone is entitled to a mortgage, and when they default, they are entitled to stay in the house they can't afford, because...just because, I guess.

And he is relatively kind to his old institution, the Fed, except obliquely in connection with the decision to let Lehman fail. Nothing about lax bank supervision or incompetent monetary policy.

[Chris]

"Too big to fail" seems to have been a direct objective for many institutions. Once you achieve that status, seems you can do anything (and loot the company in the process).

[Rick Ballard]

The "social benefit" to be derived through the mechanism of the MBS was a higher percentage of homeownership, based upon the premise that an "ownership society" is better in some (not necessarily measurable) way. It was a response to the "do the slums make the people or the people the slums?" question that came down on the side of environment being causative. It was nicely tricked out by the use of algorithms based upon past performance (this is known as "driving by the rear view mirror") with the proviso that a certain number of bad apples won't spoil the whole barrel - if the barrel is consumed quickly.

The development of derivatives was a necessary adjunct to provide the pension fund managers who own the bulk of the MBS a pair of illusory suspenders to match the wondrous algorithm belt.

Today we stand at an impasse which could best be described as a "Mexican standoff", with the pension fund managers clutching a live CDS grenade in each hand, pins pulled and fingers loose on the handles. Treasury and the Fed have the results of the Lehman auction, the FM's auctions and the WaMu auction in hand, they can put a decent value on any particular MBS with reasonable certainty - but they can't buy the really stinky tranches out without the pension funds tossing the grenades.

The other politically tricky part of the equation is that DeutscheBank, Credit Suisse and UBS are all very large players in the stinkiest stuff - bailing out foreign issuers of MBS is a very tough sell.

I don't believe that TurboTimmy and his boss are anywhere near close to having the requisite ability to resolve the problem and I'm not sure anyone else would be either. Buying up all the "bad" stuff won't do the trick unless all the "good" stuff is picked up as well. It can be done but I don't believe it can be done very quickly. I'd put the time constraint at about three years.

[BR]

Dear Kim, re yrs in the Sunday, Sunday thread - U w s, D w f - I wonder if other conserv. sites are experiencing similar impediments to the free flow of speech. When there was a technical change at wiz, it became more difficult there to find archive items. I've now saved and printed my favorite thread here. Hopefully TM is backing up JOM's, including The Bald Man series!

JustAThought: since it's a bit late to openly exchange email addys now, perhaps we all shd start many lefty blogs where we can continue our wonderful chats. We can create a troll or two, just for the illiterate profanities and authenticity :)

[RichatUF]

bad, I looked for Rick's old comment and all I can say is that SixApart has thrown a pretty big monkey wrench into how the comments are indexed with search engines too.

[BR]

Wish I could find a better photo of the painting on the wall of San Francisco's La Cumbre. Here it is on their menu, top lefthand corner.
http://farm1.static.flickr.com/76/204598389_185eb3405c_o.jpg

They have The best carnitas burritos!
Crispy on the outside, soft on the inside.

[bad]

Thanks Rich, that's an interesting map. I've got it bookmarked. I appreciate your help in sorting through this stuff.

I need repetition and everyone's patience is greatly appreciated.

[bad]

Are the mortgages comprising the stinkiest stuff from selected lenders or evenly spread across the spectrum? Is that even known?

[bgates]

I never saw the beginning of "First Blood" before. The chief of the overly aggressive, anti-military police force - civilian defense force? - drops off Rambo just past a bridge marking the boundary of the police chief's little town, "Hope".

[Rick Ballard]

Bad,

There are spreadsheets which can be downloaded from the map site. They are state level summaries but still very interesting in that total dollar exposure can be derived very easily. That's where I picked up on the fact that over 50% of the dollar amount in bad ARM mortgages comes from good old CA.

I would really like to see bad credit data split by age group. I have a deep suspicion that the under 40's are performing extremely poorly today in comparison to how they behaved as a cohort in '80 or '90. The last BK code revision was necessitated by their unwillingness to stand behind their word and that CA data tends to reinforce my supposition that it's a 'new generation' issue which absolutely totaled the MBS algorithms.

The damned banks drove over a cliff while looking in the rear view mirror.

[RichatUF]

Thanks Rick, and great comments. Wanted to add that you also pointed out that TurboTimmy will also sit atop the IRS while 2 investigations, the UBS millionaire tax cheaters and Madoff are ongoing. What better person than a tax-cheat to be forgiving to other tax-cheats.

the pension fund managers clutching a live CDS grenade in each hand, pins pulled and fingers loose on the handles. Treasury and the Fed have the results of the Lehman auction, the FM's auctions and the WaMu auction in hand, they can put a decent value on any particular MBS with reasonable certainty

If a pension fund were to have an MBS and a cds contract with the mbs as the reference entity, wouldn't it be the counter-party that would be left without the chair? Hummm....

[Extraneus]

What would have happened if Bush had just said, "This isn't a unique situation. We've had recessions before and always will. And during recessions, moreso than during expansions, some businesses fail, and that includes banks. We have FDIC insurance for anyone worried about losing their savings. Meanwhile, to recover most quickly, the best thing we can do is to lower taxes, but if we don't it could get much worse."

[Old Lurker]

"the fact that over 50% of the dollar amount in bad ARM mortgages comes from good old CA...I have a deep suspicion that the under 40's are performing extremely poorly today in comparison to how they behaved as a cohort in '80 or '90. The last BK code revision was necessitated by their unwillingness to stand behind their word and that CA data tends"

As usual, RB gets right to the heart of the matter. Along with all the other pathologies afoot in CA, not the least is the fact that out there, home mortgages are generally non-recourse to the borrowers, meaning stressed borrowers can mail the keys to the lender and cannot be chased for any shortfall. Had bankers had any sense, they would have refused to do mortgage business in that state under those rules.

[Charlie (Colorado)]

Hmm, Prof. Blinder never mentions FNMA at all - that's waht we call keeping the blinders on.

Someone had to do it.

I think the bitching about the "ownership society" idea is less than well thought out, though. The immediate idea behind it, going back to as I recall the "Contract with America", was that providing Section 8 money or housing assistance wasn't as good as helping people to buy and own something. As Cato Institute points out, the more general notion goes back to, eg, Locke. What's more, the Bush notion of the ownership Society included not just owning a home, but owning the results of your labor; having actual personal assets in place of Federal IOU's for Social Security; and school vouchers so parents would own and control their childrens educational choices.

By conflating the "ownership society" with goofily-structured loans that came from Carter and Clinton programs, and which were maintained in the face of attempts to reform them by Bush and McCain (among others), you're not only falsifying the history of it, you're playing into the hands of the people who would rather blame Bush than see any responsibilty end up with Congress.

[RichatUF]

bad-

Are the mortgages comprising the stinkiest stuff from selected lenders or evenly spread across the spectrum? Is that even known?

It is more of a state problem than a specific bank problem. CA, FL, MI, OH, NV, and AZ capture about 80%.

Some individual institutions were highly problematic. The former Golden West Financial Corp (and World Savings Bank), owned by Herb Sandler before he sold it to the former Wachovia seems to be have been particularly bad. The former WaMu bought another CA based mortgage orgination company, but I've forgotten the name, but it seems to have done its job as well.

[bad]

I should have specified "other than Pritzker's and Golden West."

[Waitasecondiceworm]

Obama has been suing over loan criteria since 90.

[bad]

Obama has been suing over loan criteria since 90.

Isn't it a smear to point that out?

[Rick Ballard]

Charlie,

The "goodness" of the intentions behind the origins of the concept are immaterial. As with most Lockean concepts, the sail to anchor ratio tends to be vastly underestimated. The distortions put in place by Congress through the CRA are rather typical of the degeneracy practiced in every democracy which has ever extended suffrage to those who have never put a dime into the treasury.

It would be so nice if those who allow themselves to be guided by well reasoned good intentions actually got to pay the bill when they gang aft agley.

[Boatbuilder]

Charlie, you beat me to it, but I agree. Alas, Rick is also dead on, as usual.

As I remember it, one aspect of facilitating ownership of homes rather than just subsidizing rents was that people with some "skin in the game" (where have I heard that phrase?) will be more likely to actively participate in their communities, promote neighborhood interests, etc. (One of the principles underlying the home mortgage tax deduction subsidy, I believe). The slumlord approach hasn't worked out too well either.

[glasater]

Barry Ritholtz Blog has an interesting thread on CDS's--would that be the proper way to call them?--written by someone called Chris.

Chris writes:

I am especially interested in your comments on

1) the issue of what to do with CDS written against the top four money center banks, which are all under de facto public ownership as will become apparent as loss rates eat remaining private common and preferred; and

2) how to bifurcate the functionality of current CDS into a) an exchanged traded, index like product that tracks the spread/volatility of a corporate single name issuer and b) an exchange traded form of bond insurance with minimum 50% collateral vs net exposure (par less current estimated recovery rate, which will vary with spreads).

Thoughts?

Chris

Thoughtful comments follow and are an interesting read.

[Patrick R. Sullivan]

Without the Alicia Munnell paper published by the Boston Fed in the early 90s, claiming to have found racial discrimination in mortgage lending, there would have been no 'affordable housing' mania in the first place. For Blinder to give 1998 as the first mistake is disingenuous.

[MikeS]

I'm a teensy bit out of my element here, but it is obvious to me that it was a big mistake not to spend the first half of the TARP funds the same way Obama spent the Annenberg education funds in Chicago. He gave it to community organizers.

[Antimedia]

For Blinder to give 1998 as the first mistake is disingenuous.

More than disingenuous. Completely inexplicable. The roots of this problem can be traced back to FDR, when the idea first gained real traction that it was the government's job to bail out the "people" whenever bad times came. It was only a matter of time before the rich and greedy found a way to profit from the idea, at the expense both of the people who need it the most and the longevity of the American experiment.

[bad]

Does Alan wear blinders?

[jimmyk]

Without the Alicia Munnell paper published by the Boston Fed in the early 90s

The Community Reinvestment Act dates back to 1977. Then there was the 1994 Riegle-Neal Act that made CRA ratings a consideration for determining whether to allow banks to have interstate branches.

[Mel]

glasater-

Ritholtz is a good link! And interesting commentary. I had only one observation in their dissembling of the subject. They continue with the premise that CDS' are insurance contracts, when they are priced, and behave, as options contracts. The CDO/CMO markets, as was experienced by the demise of the GNMA contract at the Chicago Board of Trade, have no ready and liquid hedge vehicle. They, instead, made up a private option market, when swaps were all the rage, called it a "form of insurance", priced the probability of default, applied present value of a dollar, and sold them as fast as they could package them with the CDO/CMO product they were stuffing out the door.

Not that I witnessed this in any form, of course.

Much.

[E. Nigma]

Not being a student of this (but trying to learn), I found that a speaking, question and answer session at the Heritage Institute by Young Phil Graham (you may remember him from the US Senate, 1984 -2002), on CSPAN shown yesterday informative.

He said he had never heard of CDS's in 1998 when they voted to repeal Glass Steagle (and never imagined them either), but that it seemed a good free-market response to this, and that the banks who did this "honestly" seemed to be doing better than the others (if I remember arightly).
He also thought the biggest villains of this disaster were the Bond Rating agencies, which acted as a cartel and greatly contributed to this problem by improper due diligence. And that it would happen again if this situation isn't improved. Catch if it shows up on CSPAN again.
Persuasive stuff.

[Jim Miller]

I'm still chuckling at his use of "whoppers". Granted, the main meaning of "whopper" is some large thing. But the word also means, by a straightforward extension, big lies. Can't say he didn't warn us.

[RichatUF]

LOL. I had to re-read it to catch that Jim.

[Neo]

Funny how the whole GSE "playground for political hacks" gets overlooked again by yet another Democratic advisor.

Even Tim Geithner said in hearings last week that this "thing" was well under way in the Spring of 2007, well before the Lehman or TARP "crap sandwich".

[JB]

Dear Alan Blinder, caretaker at the Fed:
the answer is quite easy, Alan. You and your fellow Fed leaders made money cheap. That led to runaway bubbles in stock markets, bond markets, and housing. You should have bit the bullet with the first internet stock bubble. You lacked the will. Go read the Fed reports that cam out in '87 and '88 concerning the last stock market failure, and last real estate bust. What was the solution, Alan? It was Volcker's interest rate hikes. Yes, they caused pain. And then the recovery happened. Your path has led to the downward spiral of the likes of Japan's. It will end no differently if you do not make money worth something.

[fdcol63]

As Margaret Thatcher said (probably paraphrased):

"The problem with Socialism is that eventually you run out of other people's money."

[Dicebucket]

The following statement of Blinder's is the most outrageous, untrue, and downright ridiculous uttering imaginable. It singly disqualifies this guy from any iota of believability:

FIDDLING ON FORECLOSURES The government’s continuing failure to do anything large and serious to limit foreclosures is tragic. The broad contours of the foreclosure tsunami were clear more than a year ago — and people like Representative Barney Frank, Democrat of Massachusetts, and Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, were sounding alarms.

Take some time and review actual real sources that lay out the REAL reason for this Democratic-caused catastrophe!!

1999: Early Warning --New York Times:
http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260

2003 - 2005: Calls call for more regulations; opponents poo-poo risk of any harm from sub-prime lending.
“Sub-prime loans are virtually riskless”: Franklin Raines, Fanny CEO
http://www.breitbart.tv/?p=184743

In 2005: Fannie Mae/Congressional Black Caucus relationship
http://www.youtube.com/watch?v=usvG-s_Ssb0&eurl=http://www.americanthinker.com/blog/2008/09/fannie_mae_and_congressional_d.html

2008: Wrap-up: Continuous warnings ignored, opponents block new regulations, culminating in bailout:
http://uk.youtube.com/watch?v=JsfMicOgufA

[Charlie (Colorado)]

Rick, you neatly avoided pretty much everything I said, and re-confounded "Ownership Society" with the CRA, which had effectively nothing whatsoever to do with it, being as it was last modified by Clinton and was protected from all attempts to make the loan process more fiscally sensible or even auditable by Frank, Schumer, and Obama.

I get you don't like the CRA; I don't either. But would you mind finding someone who is arguing for it to respond to? Or, contrariwise, would you explain to me what's wrong with how privatizing health care, extending school choice through vouchers, and making Social Security into a real asset program?

The point is that you're using "ownership society" for a law connected in only the vaguest way to the actual proposal, simultaneously smearing Bush with a Carter-era idea and smearing a free-market approach to several major issues by connecting them with a decidedly non-free-market law. It would seem that between being factually wrong and playing into the hands of people who want to blame free-market approaches for the problems we agree have been caused by government intervention, you wouldn't want to continue it, but maybe that's just me.

[Rick Ballard]

"would you explain to me what's wrong with how privatizing health care, extending school choice through vouchers, and making Social Security into a real asset program?"

What's wrong with them is that each one will be perverted in the same manner that CRA perverted the structure of the MBS to the point it has reached today. There is no way to prevent the perversion short of 'one party, forever' rule. The strings attached to NCLB vouchers are now in the hands of people who owe the educracy big time. It's going to take Ayers and his ilk less than two years to choke off voucher exits (schools showing "improvement" will be exempted) and money poured into the real dumps at quite an amazing clip.

There is no law on earth which progressives can't corrupt and destroy if they put their minds to it and any "good intentions" which involve expansion of government 'oversight', whether in education, pensions or health care are invitations to increased governmental control.

A second level response to the 'ownership' society is that roughly 35% of the population does not possess the mental faculties necessary to inform their decisions in a manner which would prevent them from becoming wards in any realization of Lockean ideals. I understand that many Lockeans have lofty aspirations concerning 'freedom' but so did Marx. I would prefer a government which was so small that the concept of it being of 'help' (outside of defense) would be met with laughter due to its minuscule size.

[glasater]

Zero speaks and the DOW goes into the dumpster. What a guy.

[clarice]

He Won!

[rhodeymark]

I think this Blinker fellow is rather astute!

[rhodeymark]

A second level response to the 'ownership' society is that roughly 35% of the population does not possess the mental faculties necessary to inform their decisions in a manner which would prevent them from becoming wards
Thinkist!

[matt]

one of the fundamental issues ignored in the discussion is that the banking industry also got away with creating a number of unregulated financial instruments that significantly increased risk, and thus the potential for a meltdown. Negative amortization loans, balloon payment loans, etc all allowed people to buy much more house than they could really afford in the long term.

If in fact the term of a loan is 30-40 years, then the probability of fluctuations in income and markets should be factored into the cost of money. This was not done. The go go housing market was fueled by specific policy decisions (or non decisions) that were to the advantage of the financial community rather than the markets. The invisible hand of the market in this case had it's thumb on the scales.

[J.M. Heinrichs]

Foe bgates
"First Blood" was filmed in/around the town of Hope, British Columbia: http://en.wikipedia.org/wiki/Hope,_British_Columbia

Cheers

[steveaz]

Maybe I'm giving the man too much credit, but...

I think Bush's main goal in the final months of his administration (other than securing Iraq), was to warn investors away from the markets.

He honestly saw the impending capital grab coming with an Obama win, and in good ol' Texas fashion, wanted to spook individual investors into taking a cold, hard look at the over-capitalized bubbles that the Democrat's urban cronies had been leveraging to such profitable effect.

Bush's AG's deliberate exploding of the Maddof Scandal was part of the ploy. He could have hit any number of nails with that hammer last year, but, Maddof's took the blow. This was supposed to be a teachable moment.

Don't forget, Clintonian hack, Jamie Gorelick, made $17M from Raines/Johnson's fuzzy profits-reporting. We only know about it because George W. Bush lit the church's tent on fire.