PeakTrader.com

[administrator]

PeakTrader:

I haven’t seen any evidence that “leading” NeoKeynesian, NeoClassical, and Austrian economists determined what caused the financial crisis. It should be noted, the global economy (or a large economy) is a huge multidimensional puzzle, where all the pieces fit together perfectly.

There seems to be three major factors that caused the financial crisis:

1. The U.S. was running increasingly larger trade deficits, since around 1980. In 2005, the U.S. trade deficit reached 6% of GDP or $800 billion. The U.S. was consuming $800 billion more than producing in the global economy, while at full employment (less than 5% unemployment rate) in 2005.

Foreigners had to sell their goods more cheaply and lend their dollars more cheaply (including through interest rates, currency exchange rates, and inflation) to keep the virtuous cycle of consumption-investment going (contributing to larger current account deficits and capital account surpluses).

However, U.S. consumers had diminished marginal utility (the opposite of pent-up demand), and dollars weren’t “recycled,” to U.S. consumers (foreigners bought U.S. Treasury bonds and the federal government spent those dollars, or reduced budget deficits, rather than “refunding” enough of those dollars back, to consumers, in the form of tax cuts)..

2. In the housing market, Congress created a giant social program, it believed it didn’t have to pay for, along with promoting moral hazard and preserving “too-big-to-fail.” If Congress began tightening lending standards when the Fed began the tightening cycle, in 2004, the financial crisis and severe recession may have been averted or lessened.

3. We had a severe oil shock, because of “Peak Oil.” By mid-2008, oil reached about $150 a barrel (the Fed deserves a lot of credit for beginning an easing cycle, in Sep 2007, while oil prices were rocketing, although the Fed caused the recession initially by keeping a restrictive stance too long with contractionary fiscal policy).

****

The homebuilding boom and lax lending standards were from 1995-07. Paul Krugman stated the housing boom was needed after 2000 to lift GDP growth (to replace the tech investment boom). However, lending standards should’ve been controlled, similar to monetary policy (by the Fed).

Bush Administration Tried to Reform Freddie and Fannie Five Years Ago
February 19, 2009

“Fannie Mae and Freddie Mac “accelerated their imprudent behavior after we attempted to regulate them. They bought almost as much mortgage debt from 2005 through 2008” as they bought in their first 30 years of their existence.

in 2003, when we sent our first members of the Cabinet up to talk about this on Capitol Hill, Barney Frank had a hearing in which they basically beat up everybody we sent up there in pretty vociferous language.

in fact, we moved aggressively in 2004 to regulate Fannie and Freddie, actually got a bill through the Senate Banking and Finance Committee only to have it filibustered by [Sen.] Chris Dodd.”

http://www.cnsnews.com/news/article/bush-administration-tried-reform-freddie-and-fannie-five-years-ago

****

Michael Bloomberg, former Mayor of New York City, stated:

“It was not the banks that created the mortgage crisis. It was, plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp.

Now, I’m not saying I’m sure that was terrible policy, because a lot of those people who got homes still have them and they wouldn’t have gotten them without that.

But they were the ones who pushed Fannie and Freddie to make a bunch of loans that were imprudent, if you will. They were the ones that pushed the banks to loan to everybody. And now we want to go vilify the banks because it’s one target, it’s easy to blame them and Congress certainly isn’t going to blame themselves.”

****

“By 2007, 55 percent of all loans made by Fannie and Freddie had to be “affordable.” By June 2008, there were 27 million subprime housing loans outstanding (19.2 million of them directly owed by government or government-sponsored agencies), with an unpaid principal amount of $4.6 trillion.

Almost 50 percent of all mortgages outstanding in the United States in 2008 were subprime or otherwise deficient and high-risk loans.

Two-thirds of these mortgages were on the balance sheets of government agencies, or firms required to buy them by government regulations.”

****

Dan, actually, it went like this:

Borrowers were able to to buy houses they couldn’t really afford, and lenders were able to make lots more money on more loans.

Lenders knew they’d be bailed-out by “too-big-to-fail, which they were with TARP, and knew the music would eventually stop.

Do you really believe banks would lend money to people with no down payment and no income without government encouragement and support?

****

JackD, you’re in denial. Congress not only created the moral hazard, it promoted it. Most borrowers and lenders behaved rationally, not foolishly. Of course, the policy was foolish, and Congress was outwitted (I guess, politicians like Dodd and Frank thought they were so clever, lol).

Where do you think the money came from to make the loans? A huge portion of it came from Fannie and Freddie. Lenders would lend and loans would be packaged into mortgage backed securities. Fannie and Freddie bought mortgages and sold mortgage backed securites to make more loans. So, money was recycled to make more loans. With the exception of Fannie and Freddie, risk was diversified, on a global scale.

Too many risky loans was the problem, not betting on them. You can buy a $5 stock or security for $10 and it may rise to $20. However, the question is why are there so many $5 stocks or securities, in the market, not whether they’ll rise or fall?

****

run75441, your assumptions and interpretation of the data are false. The homeownership rate rose from 64% in 1994 to 69% in 2005 (and it’s now below 65.5%). There were booms in homebuilding, lending, refinancing, and home improvements. Congress created and facilitated the conditions that made the booms unsustainable.

You just can’t accept the root cause of the financial crisis was too many risky loans, facilitated with the encouragement and support of Congress.

Asset markets will rise and fall, and there can be a huge fall in asset prices with a mild recession, e.g. 2001.

If lending standards began to rise in 2004, when the Fed began tightening the money supply, the result would’ve been a more sustainable and optimal housing market, with much less spill-over into the macroeconomy.

****

It should be noted, given the homeownership rate rose from 64% to 69%, and then fell below 65.5%, a large portion, if not most, of the home loans may have been categorized as “high-risk” loans.

Also, many homeowners refinanced at lower rates and extracted some equity (e.g. for home improvements, spending for other goods & services, or traded-up for more expensive homes). So, many of those mortgages eventually became “underwater.”

---