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April 05, 2009


Good point on the "ersatz capitalism": to the extent that government gets involved in commerce, it distorts markets and plays favorites with some companies over others, whether intentionally or on a de facto basis. And, indeed, by bailing out companies government socializes losses while gains remain private—a pretty disgusting state of affairs, especially considering the amount of treasure involved.

However, accusations of fraud should be made only with the greatest of care. Having read the transcript I conclude that Black is indeed a crank, paranoid or otherwise. The mortgage debt crisis got started not with self-deception more than fraud but it didn't happen in boardrooms, it happened in government offices. The government relentlessly pushed the gutting of established lending standards and explicitly recommended lending according to these practices. In other words, the government was the prime persuader that these debts were good.

I keep seeing references to the rating agencies complicity or collusion but that's not the case. The rating agencies took their lead from government bodies who provided rationalizations of the soundness of mortgages loaned on relaxed standards. One can rationally complain about rating agencies' conflicts of interest, but rating subprime and other lousy mortgage debts as AAA has nothing to do with that problem. Like everybody else (government, retail banks, investment banks and consumers), the rating agencies made poor risk management decisions based on a belief that housing prices would continue to rise.

"I think the reason they keep on coming back, the reason the zombie ideas won’t stay dead, is the lure of an easy solution, that you can just wave a magic wand and the problem goes away, and they’re still looking for magic."
(Paul Krugman on the "Cash for Trash" Program)

Belief in the "free market" is one of those zombie ideas, but the ideologically-challenged DP/RP managing elites keep shrieking for more brains.

The system of privatized profits for the rich and socialized costs and risks for the rest of us is no new invention. It's been going on for hundreds of years, under the false banner of "capitalism", which, in Adam Smith's terms, does not now exist if it ever did.

The presumed "freedoms" that right-wing libertarians talk about are based on the state-protected and publicly subsidized power of corporations and the financial industry, and the military empire required to advance and protect their profits.

"I'll be able to rant and rave about the marvels of the free market, while I'm getting properly subsidized and defended by everyone else, through the nanny State. And also, this has to be risk-free. So I'm perfectly willing to make profits, but I don't want to take risks. If anything goes wrong, you bail me out." (Free Market Fantasies: Capitalism in the Real World)

You can point you finger at the government --rightfully in some respects. But don't forget to ask the important question, Idler:

Who lobbied for the "gutting of lending standards" and regulations? It leads back to the corporate board rooms, doesn't it, Idler?

If you read the entire transcript carefully, you would have noted Black's contention that the rating agencies never examined a single loan file. If true, and I have no reason to doubt it, that's collusion in fraud of the worst sort.

Terry, the gutting of lending standards sprang out of government advocacy of home ownership. The industry underwrote loans for many decades under certain standards. The change in the standards coincides not with any change in business but with changes in government policy and the actions of many government or government-affiliated organizations. Some private companies got on the bandwagon and were celebrated by the political advocates of relaxed lending standards.

Here's some language from a 2002 report entitled "The Potential and Limitations of Mortgage Innovations in Fostering Homeownership in the United States, by David Listokin, et al., of the Fannie Mae Foundation:

"The 1992 Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA) mandated that the GSEs [government sponsored entities, such as Fannie Mae and Freddie Mac] increase their acquisition of primary-market loans made to lower income borrowers...Spurred in part by the FHEFSSA mandate, Fannie Mae announced a trillion-dollar commitment.

"The result has been a wider variety of innovative mortgage products. The GSEs have introduced a new generation of affordable, flexible, and targeted mortgages, thereby fundamentally altering the terms upon which mortgage credit was offered in the United States from the 1960s through the 1980s..."

There's a lot more where this came from. I must say that the HFEHSSA sure sounds Orwellian today. However, I believe those who believed in its mission meant the name sincerely. They, like others, were caught up in mass group-think about housing prices, and they were also infected with uneconomical thinking about housing.

I'm not sure what Harry's ranting about since the market was far from being free. It is indeed hard to imagine a truly or completely free market, for a variety of reasons, good and bad. However, market realities will always assert themselves as surely as there continues to be economy of matter and energy in the universe. Distorting markets, as the government did in spades with the subprime fiasco at best only postpones those effects by masking them and compensating for them—while one can.

This is by no means to say all fault is with the government. Far from it. But then heavy regulation inevitably leads to over-chummy relationships between government and business.

On the issue of the rating agencies, I would caution against taking Black's word about anything. Let that caution be at least one reason to doubt it. In any case, what you describe is negligence, perhaps of a criminal nature, but not fraud. There is no sane motive for the rating agencies to fail this way. It threatens their continued existence. The rating agencies have a conflict of interest problem because they receive fees from the interested parties, but one has to explain their sudden catastrophic failure of rating. If they were habitually corrupt, we wouldn't have had to wait for this particular event. This event was characterized by failures of risk management at all levels; the rating agencies along with the government entities, the investment banks and other traders and consumers.

Re: " realities will always assert themselves as surely as there continues to be economy of matter and energy in the universe."

This is one of those zombie ideas that Krugman was talking about. The invisible hand is imposed by those groups that hold power in any illegitimate (e.g., anti-democratic) system. The only component of our system that is at least to some extent accountable to the public is government, although I would prefer no government. The question is how to get to there from here.

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