A while back, I favorably quoted this line from Larry White: “One can’t explain an unusual cluster of errors by citing greed, which
is always around, just as one can’t explain a cluster of airplane
crashes by citing gravity.” Soon afterward, Brad DeLong retorted:
Larry White writes that those who blame the crisis on greed are wrong
because “greed… is always around” and you cannot explain a variable
result by a constant cause “just as one can’t explain a cluster of
airplane crashes by citing gravity.” I say that the same is true of the
CRA. It has been around in more-or-less its current form for a
generation.
While there’s a sense in which both White and DeLong are right, I’ve realized that there’s a more important sense in which they’re both wrong. Yes, you can’t explain variation in terms of constants; this much is true. But you can explain variation in terms of a variable bundled with a constant.
Non-economic example: If a soldier gets shot and killed, can you say “The reason is that he wasn’t wearing a bulletproof vest”? In one sense, you can’t; after all, what about all the days where he didn’t wear a vest and didn’t get killed? But the common sense interpretation of the facts still allows us to blame the lack of a vest; the soldier died as a result of a variable (the bullets) bundled with a constant (the lack of a vest).
My favorite economic example: European labor market regulation and unemployment. They had these regs back in the sixties when their unemployment was low. So how can you blame their unemployment on their regs? Simple: The cause of high European unemployment is a variable (various shocks) bundled with a constant (the regs).
None of this shows, of course, that e.g. the Community Reinvestment Act was an important cause of the mortgage crisis. My point, rather, is that you can’t rule out such hypotheses merely by pointing out how long some legislation has been in place. Indeed, if you really believed that, you couldn’t blame someone’s declining health on a lifetime of bad diet and exercise, could you?
READER COMMENTS
Greg Ransom
Feb 9 2009 at 2:00pm
Larry Wright has a bunch of very helpful papers and books on the nature of explanation and causal explanation.
Perhaps economists should read a bit in this very vibrant literature.
David R. Henderson
Feb 9 2009 at 2:01pm
Very nice, Bryan.
I would also add, though, re the CRA, that the revision of it in the mid-1990s and the enforcement of it in the late 1990s did make it a variable rather than a constant. See Stan Liebowitz’s piece on this put out by Independent Institute.
Greg Ransom
Feb 9 2009 at 2:02pm
Steve Sailer has a bunch of new information on just how large the CRA thing really was — we’re talking of trillions of dollars dedicated to it by B of A, Countrywide, WaMu, etc., done for the purpose of acquiring other banks (which WaMU, e.g. did a LOT).
Economists seem massively ignorant of the facts on the ground … hmmm, kind of interesting.
scott clark
Feb 9 2009 at 2:40pm
What are you getting at? If a problem occurs because of a varible bundled with a constant, then isn’t the varible still to blame? In your example, the soldier died because he was shot, not because he wasn’t wearing a vest. You can say he was shot and wasn’t wearing a vest, but the death is pretty much still the shooting. The constant isn’t too helpful here. Are you proposing that whenever we try and explain something, we say “here is the explanation + c”, like an integral in calculus?
I would prefer to think of this particular situation, with CRA and the housing boom as follows: the market can cope with a certain amount of bad policy, and over time can adjust to bad policy and still have some pretty decent outcomes, but by piling up bad policy after bad policy after bad policy, the market can no longer respond rationally. So you can’t blame the CRA as the sole culprit, since its been around a long time and things were pretty OK, but you can blame the CRA for its contribution to the total government weight and drag on people and businesses going about their daily lives, piled on top of all the other DC nonsense foisted out on the world.
Constant
Feb 9 2009 at 2:56pm
Regulation and bullet proof vests are variable and are under human control, even if they have not historically varied over some period. Greed and gravity are not variable and therefore are not under human control. Granted, we might move off planet and we might evolve, so it might be more precise to talk about degrees of variability and control.
dWj
Feb 9 2009 at 2:58pm
I think the point is that it is particularly feasible to blame the constant if the variable, or any effectively equivalent variable, is likely. I might place first blame on the soldier who fired the bullet, but if the soldier was in situation where he was likely to be on the receiving end of a bullet from someone, if not this guy right now, then the lack of a bullet-proof vest becomes more culpable. In an example I recently used (in the context of “affordable” mortgage products that turned out not to be), the Pinto was a perfectly fine car as long as nobody ever got rear-ended.
If the CRA was a powder keg, and the match didn’t come around until now, you can still suggest that the CRA had a cost that wasn’t being advertised.
8
Feb 9 2009 at 3:16pm
What ever happened to sloth, gluttony, lust, vanity, wrath and envy? They don’t make the cut on the left?
Kit
Feb 9 2009 at 3:21pm
An electrical analogy from NumberWatch:
The crunch – two analogies from physics
The ultimate result of shielding men from the effects of folly is to fill the world with fools. – Herbert Spencer (1891)
Take a sample of gas between two electrodes and apply a voltage known to be high enough to cause electric breakdown. This was a system first described by Nobel Laureate, Max von Laue, in 1925. The breakdown discharge does not take place immediately: although the system is unstable, it awaits a triggering event, such as a cosmic particle. The observed time lags to breakdown are highly scattered (exponential distribution).
Imagine instead of suddenly applying a constant voltage we apply a ramp function rising linearly from zero. The voltages at breakdown are again random, depending on a triggering event (among other factors). The damage done by the discharge depends on the energy in it, which varies with the square of the voltage, so a long time lag means much more damage.
Blackadder
Feb 9 2009 at 3:35pm
Blaming the CRA seems problematic to me for another reason. Generally speaking, when the government forces business to sell something at below market prices, the result is not a bubble but a shortage. When the government imposes rent control, for example, property owners respond by renting less, which leads not to a rental bubble, but to a rental shortage. Nor would the situation change if, instead of placing direct limits on the price that can be charged in rent, government were to limit the ability of landlords to check the credit history’s of minority tenants, or to demand such things as a security deposit or first and last months rent at the beginning of a lease, or were to take various steps to “encourage” landlords to rent to more minorities. Landlords want to make money, and if you force them to lower rental standards in certain cases and rent to people who aren’t likely to pay them back, the rational response of the landlord will be not to lower standards across the board, but to tighten standards in other areas to ensure that they can still turn a profit (and if they can’t do this, then the rational response will be to get out of the renting business altogether).
So far as I can tell, everything said above about renting should apply equally to lending. If the CRA forces a bank to make a bad loan, the rational response is not for the bank to make even more bad loans, but to be extra careful with its non-CRA mandated lending. So blaming the CRA for the housing bubble is like saying that inflation is caused by the government turning off the printing presses.
Carl The EconGuy
Feb 9 2009 at 3:41pm
Gravity is a constant that always manifests itself in one single way; greed may be a constant, but it is much more like a mutating virus. It manifests itself in new forms whenever successful attempts to control it are made. Since politicians are greedy, their inventiveness in satisfying their own greed for political results also yields mutations. CRA as implemented during the housing bubble is an expansion of its original form, as a virus mutates to find a new niche. CRA may even be a very successful retro-virus that hides quietly but then erupts on occasion, causing great damage. When private greed and public greed mutate simultaneously, you a crisis of epidemic proportions. You can’t stop mutations, and that’s a fact.
Troy Camplin
Feb 9 2009 at 4:05pm
Yes, greed is a cause, but we still have to explain how all those other greedy people out there didn’t do this or that crooked deed. The real question should be: what else, other than greed, caused them to do this or that crooked deed? I’ve tended to attribute crookedness to stupidity. Smart people aren’t crooked, because they understand they will make plenty of money being honest and good, and that just as importantly, they won’t have to pay for being good in the same way one will have to pay for being bad. Too often, the crooked think they are too smart to get caught, which only underlines the fact that they are in fact stupid. Another way of putting it is as Socrates put it: the difference between good and bad is ignorance. The bad person is simply ignorant of the outcome of his actions. Teach people the outcome of bad actions, and they will cease to engage in bad actions — because it is in their own self interest.
Barbar
Feb 9 2009 at 5:56pm
Generally speaking, when the government forces business to sell something at below market prices, the result is not a bubble but a shortage.
Yes, thank you Blackadder! Funny how a rather trivial line of thought completely escapes most of the people here.
See also Steve Sailer’s confusion about how the horrible immigrant hordes caused California real estate prices to skyrocket.
That this basic bit of logic escapes the attention of “hardheaded” people suggests to me that hardheadedness might not be fully explained by a love of logic, economic or otherwise.
Troy Camplin
Feb 9 2009 at 6:04pm
The bubble occurs until the shortage occurs. People buy and buy until they create a shortage. There is a lot of land in this country. Still, prices were going up, indicative of both shortages and bubbles.
What the government was doing was “encouraging” low interest rates and mortgage availability. So lots of people were buying property, driving up prices everywhere. Of course, a really cheap house only became a cheap house under those conditions. You did see shortages in places with little available land. Here in Dallas, the suburbs blossomed.
Barbar
Feb 9 2009 at 6:26pm
The shortage in this case would be in the credit market. If you run a bank and the government forces you to lend out money at a lower interest rate, how do you respond? Do you try harder to screen out bad credit risks, or do you encourage bogus applications and hand out interest-only mortgages? Do you being growing your business, or do you cut back? Think please.
Nick
Feb 9 2009 at 6:35pm
It would be more profitable to view regulations as operators rather than constants.
DJ
Feb 9 2009 at 7:09pm
Necessary versus Sufficient conditions.
Blackadder
Feb 9 2009 at 7:22pm
The bubble occurs until the shortage occurs.
A bubble involves overproduction. The fact that stores sell off their inventory immediately after price controls are instituted does not a bubble make.
Blackadder
Feb 9 2009 at 7:40pm
Here’s another way of getting the same point. Suppose that you run a bank and one day the local mafia don comes into your office and says that he wants you to make some loans to certain associates of his. Looking over the applications, you can see that it’s unlikely these “loans” are ever going to be repaid. But when a mafia don “encourages” you to do something you had better do it, so you approve the loans.
What is the rational response to this? Is it to go on a lending spree, and start lending to all sorts of people who aren’t likely to pay you back, even though you don’t have to? Or is it to try and tighten up elsewhere to compensate for the lost revenues anticipated from these loans (and maybe think about going into another career or at least moving the bank out of the neighborhood)?
If someone tried to blame the housing bubble on this sort of extortion racket, he’d be laughed off the stage (and not just because the scale wasn’t big enough). An extortion racket can have a lot of bad economic effects, but it doesn’t tend to cause an artificial boom in the extorted industry. Yet it is exactly that sort of reasoning that would seem to be behind claims that the CRA caused the housing bubble.
Patrick R. Sullivan
Feb 9 2009 at 10:05pm
I’m not following Blackadder’s argument. The bubble was in the housing market, thanks to lending institutions being forced to make loans to people who hadn’t qualified under the normal standards. Rising prices of houses indicates a ‘shortage’.
But the subprime loans were at higher interest rates, which also indicates a ‘shortage’.
Troy Camplin
Feb 9 2009 at 10:14pm
I have 100,000 units of a good, which I am selling at 1000 units a year at $100,000. The government comes in and says I have to sell my units at $10,000. Suddenly lots of people buy units of my good. That is a bubble. Then I run out. That is a shortage, resulting in a crash.
The fact that people don’t understand this simple concept is why we are in the situation we are in, and why it’s going to get worse with this “stimulus” Obama is trying to shove down our throats.
Barbar
Feb 9 2009 at 11:01pm
You guys are killing me here.
Troy writes:
The government comes in and says I have to sell my units at $10,000. Suddenly lots of people buy units of my good. That is a bubble.
Really? Are you building more units to benefit from the really low prices? Do people feel that the units are ridiculously priced and unaffordable, but are buying because they expect future prices to be even more ridiculous and unaffordable? No? Then how is it a bubble? Yeah, your units will get sold quickly. That doesn’t make it a bubble! A sale is not a bubble!
How is this not astonishing economic illiteracy masquerading as superior insight?
Patrick writes:
But the subprime loans were at higher interest rates, which also indicates a ‘shortage’.
Higher default risk = higher interest rates. This doesn’t reflect a ‘shortage.’
It’s true that easy credit = higher housing prices. But the point is that banks did not behave as if they were being FORCED to dish out easy credit. If you are being forced to give out credit at a below-market price, you don’t stop checking borrowers’ statements of income, to give just one glaring example. You probably aren’t growing your business and earning record profits either.
Blackadder
Feb 9 2009 at 11:39pm
Let me try another analogy here. Suppose that the government were to impose a tax on lending (say, a fixed percentage of the amount lent). Would this cause a housing boom? Of course not. By raising taxes on lending you reduce the profitability of making loans, which will lead people to lend less than they otherwise would.
The CRA, however, also reduces the profitability of lending, because it says that banks have to lend money to people who in all likelihood won’t pay them back. Lower profitability should translate into less lending, not more. Arguing that the CRA caused the housing bubble is thus akin to arguing that you can increase the demand for gasoline by raising the gas tax. The effect, if any, of something like the CRA should be the exact opposite of what is being claimed.
Patrick R. Sullivan
Feb 10 2009 at 12:05am
I’d rather you didn’t. Arguing by analogy is problematic, one of the obvious fallacies. Try making your argument in a straightforward fashion.
happyjuggler0
Feb 10 2009 at 1:34am
I’ve had both bleach and ammonia (e.g. glass cleaner) in home(s) for decades, but they’ve never blown me up. So why would they blow up an ignoramus who visits my home, makes a major mess, and decides to mix all my cleaning agents together in order to make sure everything can get clean. After all, they’ve been stable for decades.
This is essentially what DeLong is saying, that if something doesn’t cause a problem for decades, it can’t be held partially responsible for something, even when mixed with new variables.
With all due respect, that is just plain dumb.
P.S. For those who didn’t know, a mixture of bleach and ammonia is *very* unstable, and can you can indeed blow yourself up by mixing the two together. Or maybe you’ll gety lucky and there won’t be an explosion of some sort. Don’t bet on it though.
Steve Sailer
Feb 10 2009 at 3:57am
Like many, I was long skeptical about GOP contentions that the CRA forced banks, such as Washington Mutual which pledged $375 billion in CRA loans, to make bad loans:
“”How could the government hold a gun to the financial institutions’ heads and force them to make hundreds of billions in stupid loans? Sure, giving out $375 million in stupid loans to get the government off your back, that would make sense. $3.75 billion, maybe. $37.5 billion, conceivably. But $375 billion, no way. Nobody would promise to give away $375 billion to dubious borrowers unless they thought it was a great idea. They’d leave the industry before they’d promise to hand out $375 billion to people whom they doubted would pay it back.”
I finally figured out, however, how the CRA actually exacerbated the Housing Bubble and Bust, and explained it in a February 1, 2009 article, which you can read here:
http://vdare.com/sailer/090201_meltdown.htm
It’s a more sophisticated analysis than you’ve heard before.
Steve Sailer
Feb 10 2009 at 4:03am
In brief:
How does a bank get more market share and revenue growth?
One major way: by buying other banks. And to do that, you have to pass through the CRA gauntlet. If you aren’t willing to lend to people the government wanted you to lend to, then you were out of luck at the mergers and acquisitions game.
So, the CRA implicitly selected for Kool-Aid Drinkers, the ones who truly believed that lending more hundreds of billions to CRA-favored borrowers was a Great Idea, such as WaMu’s Kerry Killinger. They’re the ones whom the government allowed to build empires. (Unfortunately, their houses turned out to be built on sand.)
I missed understanding the impact of the CRA because I kept asking myself: “How could the CRA force a banker who thinks lending more to minorities is a bad idea to lend more to minorities?” I kept trying to imagine the CRA’s effect on the already crazy-stupid WaMu, and how that couldn’t have been all that significant.
But I should have been thinking about the other side of the coin: all the sane-smart banks that didn’t get to get big like WaMu did because the government rigged the acquisition process so that crazy-stupid banks were more likely to get merger approval. WaMu got permission from the government to make 29 acquisitions from 1990 onward. A smart-sane bank wouldn’t.
Blackadder
Feb 10 2009 at 8:18am
Pat,
Arguing by analogy is “one of the obvious fallacies”? News to me. But if you want me to state the argument without using analogies, I will. The CRA imposed additional costs on banks for lending. Imposing additional costs on a business doesn’t create a bubble in that business. So arguing that the CRA caused the housing bubble does not make much sense.
By the way, am I the only one who finds Steve Sailer’s professed “long skepticism” about the role of the CRA in the housing crisis a little hard to swallow?
Thomas DeMeo
Feb 10 2009 at 10:46am
The CRA introduced higher risk mortgages into the system, but it was the introduction of defective modern risk management instruments combined with outright fraudulent ratings mechanisms that made these mortgages so damaging. A handful of men in key positions could have prevented this from happening, but they didn’t.
It seems that even if the CRA wasn’t there, the false confidence of the markets would have eventually caused the same result. Risk cannot be made to disappear. It can only be diffused.
Patrick R. Sullivan
Feb 10 2009 at 10:57am
Go to any logic website, and you’ll find the false (or weak) analogy discussed.
Now that you’ve elucidated your reasoning, I see that you’ve way oversimplified. No one is arguing that adding costs to a business creates a bubble. When the govt. takes some action that adds costs to a business, that business will find ways around the new costs–if you like analogies; raising the minimum wage doesn’t have to increase unemployment, businesses have other ways to cope, such as supervising the employees more closely to squeeze more productivity out of them.
One work around for the CRA was securitization of mortgages. I.e. the loan originator passes the problem on down the road.
Anyway, it wasn’t clear the loans were ‘bad’ right away. Thanks to the extra money coming into the home market, prices rose–classic Friedman; inflation is a monetary phenomenon–people who couldn’t meet their mortgage payments merely sold the home for more than they paid for it. As more people did that the bubble got larger, until it popped.
Blackadder
Feb 10 2009 at 2:07pm
Pat,
I’m not aware of any evidence that the CRA was responsible for increased securitization, but regardless securitization will only work for a bank if it can find willing buyers for the securities. To take your minimum wage example, people sometimes say that firms won’t be hurt by the minimum wage, as they can just raise prices to compensate for their increased labor costs. But if a firm could increase its profitability by raising its prices, chances are it already would have done so. Higher prices might offset some of the additional labor costs associated with a rise in the minimum wage, but it will still leave the firm less profitable than it otherwise would have been. Similarly, even if banks could have used securitization to offset some of the costs imposed by the CRA, this wouldn’t result in the increased profitability of lending necessary to create the boom.
Now it’s true that you might not see decreased profitability for banks if there was already a bubble underway. In that case, the increased profitability of lending caused by the bubble might more than erase any drag involved in complying with the CRA. But in that case the CRA can’t be said to cause the bubble.
Suzanne Reisman
Feb 10 2009 at 2:42pm
Although the Act’s critics claim otherwise, CRA does NOT mandate that banks lend to disadvantaged borrowers who are not credit-worthy, nor did it lead to banks lowering their underwriting standards to comply with the law. According to an independent study of 2006 mortgage loan data conducted by the law firm Traiger & Hinckley LLP, CRA actually deterred banks from engaging in the kinds of risky and subprime lending that brought on the foreclosure crisis. Specifically, the findings show that:
1. CRA banks were significantly less likely than other lenders to make a high cost loan;
2. The average APR on high cost loans originated by CRA banks was appreciably lower than the average APR on high cost loans originated by other lenders;
3. CRA banks were more than twice as likely as other lenders to retain originated loans in their portfolios; and
4. Foreclosure rates were lower in metropolitan statistical areas with greater concentrations of bank branches.
To reiterate: the actual mortgage data shows that CRA deterred irresponsible lending. Further, the Treasury Department and the FDIC have emphatically stated that CRA is in no way responsible for the situation we are in today.
Instead of blaming CRA, we should extend CRA provisions to the independent mortgage companies and bank affiliates from which at least 75% of subprime loans originated. To continue to mislead the public on the benefits of CRA would lead us into situation in which more – not less – of the irresponsible lending that created our current meltdown takes place.
Steve Sailer
Feb 10 2009 at 5:10pm
You all don’t get how the CRA worked.
It didn’t _force_ Bank of America to pledge $1.5 trillion in CRA lending when it bought Countrywide. It didn’t _force_ WaMu to pledge 375 billion in CRA lending when it bought Dime Bank. Nobody makes promises that stupendously large unless they think they _might_ pay off.
No, what the CRA does is impose a selective filter on which banks get to buy other banks. Only the crazies like Kerry Killinger of WaMu who are willing to sign gigantic CRA pledges with the likes of ACORN and Greenlining are allowed to buy up other banks. The prudent, skeptical banks that don’t think it a good idea to make those kind of pledges aren’t allowed to buy other banks.
Over time, the big banks are the ones run by crazies like Killinger who think it’s a great idea to make big loans to “underserved” minorities, while the prudent bankers stay small.
Think about it…
Barbar
Feb 10 2009 at 7:26pm
Yes, think about it. The politically incorrect truth that no one wants you to hear is that finance is dominated by crazy do-gooder community activists. Unfortunately for Wall Street, prudent people who are interested in creating record profits and earning big bonuses are banished to the sidelines, unappreciated and unrecognized. It all makes sense, really, especially if you assume your conclusion first and then desperately attempt to rationalize it.
(“Like many, I was long skeptical about GOP contentions that the CRA forced banks…” sets a new record for disingenuousness.)
Steve Sailer
Feb 10 2009 at 8:05pm
Sorry, Barbar, you’re not paying attention.
Assume two kinds of bankers:
The Kerry Killingers (of WaMu) believe that following a strategy of lending huge amounts of mortgage money to people approved of by the CRA (minority and low income home buyers) is a good idea: the profits outweigh the risks.
The Ebenezer Scrooges say “Bah, humbug” to that: The risks outweigh the profits.
The government lets the Kerry Killingers buy up their competitors but doesn’t let the Ebenezer Scrooges do the same. After a decade, the management of the biggest banks is dominated Killingers, not Scrooges.
It’s a selection effect. The CRA veto over bank mergers over the last 15 years has changed who gets to run big banks, and it has changed the cultured of lending to promote those who favor imprudent lending.
Then the day of reckoning comes and it turns out that the government, ACORN, and WaMu were all wrong about the average creditworthiness of minorities and low income borrowers, and the Scrooges were right.
Barbar
Feb 11 2009 at 12:30am
This is getting ridiculous.
First off, Steve Sailer has been trying to figure out how the CRA caused the financial meltdown since at least June 2008. See this article. It’s long and there’s a lot of really quite irrelevant stuff about how homeownership can’t stop black people from rioting, but here is the money quote:
One mystery remains: Why was Wall Street was so credulous about all these dubious mortgages?
That’s the rub. At the end of the day, the CRA couldn’t force anyone to do anything: “To avoid the Community Reinvestment Act hassles, more than a few respectable institutions avoided doing business in minority communities.” So Sailer has to explain the banks making stupid loans by pointing to the housing bubble, banker greed, and banker short-sightedness. Somehow he thinks this proves that multiculturalism is more to blame than most people think, but the actual arguments he makes undercut him.
Now it’s eight months later, and Sailer has a new more “sophisticated” theory of how the CRA caused the financial crisis. He pretends to be really surprised by his new conclusion, which of course is exactly the same as the old one. Spare me.
In the new story, the government can’t force banks to make bad loans, but it can (via the CRA) prevent smart banks from growing. This leaves the market to the bad banks, and we get a financial crisis.
Of course the exact same logical flaw is still present. If a stupid bank thinks it should give away credit for free, it will take over its market, WHETHER OR NOT THE GOVERNMENT ENCOURAGES THEM. If stupid WaMu thought that giving out loans to people who couldn’t pay them back was profitable, they were going to grow no matter what. If low-income communities are being served by banks giving away stuff for free, then how exactly does a prudent bank lose out by the CRA not letting them move into the community? They wouldn’t have wanted to move in.
The stupidity of private actors in a competitive market stands on its own. But why am I wasting my time?
Jeremy, Alabama
Feb 11 2009 at 8:00am
I am certain you are correct – but unfortunately not very useful, unless it be to strictly bound the power of analytical economics. The power of a science is exactly its ability to rule out hypotheses.
If a signal is buried in many layers of noise, then time-shifted by perhaps decades, the correlation is necessarily weak and subject to many interpretations.
Sanity Personified
Feb 11 2009 at 9:49am
If low-income communities are being served by banks giving away stuff for free, then how exactly does a prudent bank lose out by the CRA not letting them move into the community?
How do they lose? By getting taken over that’s how.
If a stupid bank thinks it should give away credit for free, it will take over its market, WHETHER OR NOT THE GOVERNMENT ENCOURAGES THEM.
So WaMu, Wachovia, BAC, they all “took over their markets” by organic growth, did they now? They merely offered the cheapest credit so that everyone flocked to them. I see.
What you fail to see is that things didn’t work out according to your theory. The bad banks got bigger, and that has never happened before.
Troy Camplin
Feb 11 2009 at 9:57am
Actually, a sale that results in a rush on goods is technically a bubble. But apparently there are people who are incapable of thinking analogically. So let’s try this again.
I have a billion dollars to lend, which I want to lend only to home buyers with a high credit score at an interest rate of, say 10%. As a result, I make 10 $100,000 loans a year for people to buy houses. This results in a steady sale of 10 homes a year. Then the government comes in and strongly :encourages” me to lower the credit score I use and the interest rate. I am now going to make more loans, because more people qualify. Let’s say that it results in a doubling of houses sold. This would drive prices up, so I’d have to make larger loans. This would also encourage people to flip houses, so more loans are made. That would be a bubble. When the people who have low scores cannot pay their mortgages, I then have to foreclose on those homes and try to tell them. That drives down prices. If some people then have to sell their homes for other reasons — say, they are moving — they then find their house worth less than what they paid for it. The bubble has burst.
Now, while this is very specific to housing, it is in fact broadly applicable to other kinds of bubbles, if you remove the details.
Apparently, thinking analogically is hard.
Barbar
Feb 11 2009 at 12:08pm
Troy, of course easy credit inflates house prices and can create a housing bubble. That isn’t being questioned.
Blackadder’s point is that when the government interferes in the market to make credit easier to obtain, basic economic theory says that this backfires. Focus on the credit market. When the government strong-arms banks into giving away credit, banks that actually think they are being strong-armed are actually going to try to back away. They’re going to find new ways to ration out credit, they’re going to stop expanding, they’re going to shift capital into more profitable enterprises.
A bank that feels strong-armed is NOT going to loosen its standards, is NOT going to want to quickly expand.
Now the new Steve Sailer argument acknowledges this, but says the CRA allowed stupid banks to buy smart banks, and not vice versa, so the CRA rigged the game so that only bad banks could thrive.
1. As Suzanne notes above, CRA banks were actually less likely to give out bad loans than banks not covered by the CRA. CRA banks were also less likely to securitize their loans. You’d think Sailer would need to address this fact, but he gets around it by tossing out a barrage of mostly irrelevant statistics and anecdotes.
2. Could two “sensible” banks that wanted to merge do so under the CRA? Yes; one way to be CRA-compliant is to simply not serve certain communities at all. “Prudent” banks were also CRA-compliant.
3. If bad banks are buying out good banks, you cannot blame this all on a few bad apples and some government encouragement. In a quasi-rational world, the value of a good bank should plummet after it’s bought by a bad bank. In fact, the value of bad banks should plummet as soon as their badness becomes apparent. As far as I am aware the CRA was publicly available information. If this didn’t happen, then we have a really basic private market failure that makes me wonder why we should have expected finance to get anything right ever.
4. This by Sailer says it all: “In many industries, however, skill puts a restraint on growth through confidence and luck… In finance, in contrast, sheer boldness appears to play a relatively larger role.” In other words, finance, which was not only a huge growing part of our economy but also the part responsible for allocating capital efficiently, is basically really really stupid and not responsive to skill. If this accurately describes the industry, then I don’t see how the CRA can be relevant: stupidity and boldness will come to dominate the financial industry no matter what.
Of course I can’t really win this argument, because although Sailer looks to have something like an analytical position, it’s really more of a feeling of “yuck, all that money associated with helping black people, no wonder everything fell apart.” This position is pretty invulnerable to rational critique, so this is all actually pretty hopeless.
Troy Camplin
Feb 11 2009 at 1:07pm
Insofar as basic economic theory only posits the existence of Homo economus, the mythical purely rational human being, then it’s of little use to discussions about real-life economics. It’s a straw man increasingly understood as such. Real human beings can be strong armed without the consequences you suggest. They can also be persuaded that bad ideas are in fact good ideas. They can be persuaded that something someone is doing for their own political gain is in fact beneficial to them. And when an industry is dominated by a company or companies whose leaders are intimately tied to people in government, and who are ideologically- rather than profit-driven, then you get the kind of mess you get here. Whether the government forces, persuades, encourages, etc., the fact is that they are driven by ideology, not reality. If I am forced to lower standards or I am persuaded to through specious arguments that everyone in the U.S. should be homeowners, the outcome is the same. Again, apply the analogy in a broader sense. More conceptual thinking would make it so we don’t have to have the same arguments with different details over and over and over.
Barbar
Feb 11 2009 at 2:19pm
And when an industry is dominated by a company or companies whose leaders are intimately tied to people in government, and who are ideologically- rather than profit-driven, then you get the kind of mess you get here.
If you believe that people running the banks were primarily driven by a desire to help low-income communities, and not by a desire to make money for themselves, then it’s truly pointless to have a discussion. But hold on, you say:
They can be persuaded that something someone is doing for their own political gain is in fact beneficial to them.
So this is the “bankers are stupid” argument (not the “bankers are really in it for the poor black people” argument). Whew. Now sure, bankers WERE stupid, and so it’s silly to say that it’s logically impossible for bankers to do stupid things. But once again, that’s not what I’m saying.
You (and Sailer) are trying to “contain” the stupidity of the banks to a certain area. Basically, in your account, the stupidity was limited to a few bank executives who were closely connected to the government. Wearing ideological blinders, these bankers gave out credit to the wrong people, fueling a housing bubble and leading to a financial crash. Thus, ideological blinders are an important cause of the crash.
Once again, this doesn’t work. Large banks are publicly traded: their decisions are evaluated by equity and bond markets. According to Sailer, WaMu’s commitment to serve low-income communities was very widely known. If the equity and bond markets didn’t punish them for making these decisions, then the delusion about the profitability of serving low-income communities cannot be restricted to Kerry Killinger. The entire financial community, a multi-trillion-dollar industry whose whole existence is predicated on the idea of making profits, is implicated.
Finally:
If I am forced to lower standards or I am persuaded to through specious arguments that everyone in the U.S. should be homeowners, the outcome is the same.
Let me point out that we are not debating whether easy credit can cause a housing boom. It is perfectly clear that it can. What we are debating is the extent to which the CRA can be said to cause the housing boom (and crash). You are saying that the CRA persuaded banks that it was in their own self interest to serve low-income communities. Here is our core disagreement. My point is that the CRA made an argument that it was good for low-income communities to be served by banks in a particular way. Why would banks conclude from this that it was in their own self-interest to loosen credit terms? If anything, the government’s argument suggests the opposite: that banks left to themselves would not want to do so. So where is the persuasive force???
This is like saying that rent control laws can trick landlords into believing that lower rents are good for business. Really? That makes sense to you?
Alternative hypothesis: we had a housing bubble fueled by other (non-CRA) factors, and this coincided with banks dramatically expanding lending in low-income communities. Seeing that their profit-driven activities could be spun in a “socially responsible” light, the banks heavily publicized CRA-related stuff, and didn’t complain about government interference because they would have done it all anyway.
Nah. Much more logical to think that some black community activists and liberal do-gooders brainwashed Wall Street into making stupid decisions. Do-gooder liberal ideas are powerful, overwhelming, and dangerous. This explanation fits in much better with the rest of my world view.
Thomas DeMeo
Feb 11 2009 at 4:59pm
“This is like saying that rent control laws can trick landlords into believing that lower rents are good for business. Really? That makes sense to you?”
The point is being missed here. Most mortgages were sold by the originator. The banks weren’t landlords, they were more like rental agents. The originators weren’t exposed to the risks of the individual transaction. All of those risks were diffused in the immediate sense by risk management. But the risk was only being diffused into the overall market, it wasn’t going away.
The effect was that no one actor felt much risk, but the whole system slowly absorbed it. Now the banks are screwed not by their own individual mistakes, but by their collective poisoning of the overall market.
Barbar
Feb 11 2009 at 5:14pm
The point is being missed here. Most mortgages were sold by the originator. The banks weren’t landlords, they were more like rental agents. The originators weren’t exposed to the risks of the individual transaction. All of those risks were diffused in the immediate sense by risk management. But the risk was only being diffused into the overall market, it wasn’t going away.
Then once again, the CRA is basically irrelevant. Originators make money on volume, so they obviously have incentives to loosen lending standards as long as investors don’t care. Investors screwed up by not being cautious enough. Is the CRA responsible for this systemic screw-up? This isn’t two guys with links to ACORN any more; we’re talking about the entire global investment community. The CRA is simply a distraction clung to by people who really want to blame community activists for all the world’s ills.
Barbar
Feb 11 2009 at 5:17pm
I see that Thomas made essentially the same point in his first comment in this thread, with which I wholly agree.
Troy Camplin
Feb 11 2009 at 11:17pm
Never mind the involvement of Freddie mac and Fannie Mae, which are the two companies in question with intimate ties to the government and which were led by ideologically-driven people, I guess. And who owned a huge percentage of mortgages? And whose activities would therefore influence the market as a whole? That’s the elephant in the room you’ve chosen to ignore in your little scenario.
Barbar
Feb 12 2009 at 12:56am
Right, the Freddie and Fannie that were desperate to improve market share because their competitors were blowing by them.
It’s OK: I understand, you have a deep psychological need to blame liberal ideology for the financial collapse. I don’t want to take it away from you, with my “little scenarios” and “basic logic.” Carry on.
Troy Camplin
Feb 12 2009 at 9:44am
Yes, I do have a deep psychological need to understand reality as it actually is, and not as I so desperately want it to be, as do you. Ideology is responsible for much of what happened in the latest collapse, insofar as the government was in fact involved in it, and insofar as government actions in a democracy are based on ideology. ANd your comments about Freddie and Fannie show you don’t have the foggiest idea about what happened. Must be your ideological blinders. It’s like I’m talking to a creationist.
Barbar
Feb 12 2009 at 12:47pm
Troy: for the billionth time, I’ve acknowledged that any particular actor can be mistaken and/or motivated by ideological concerns, and I’ve acknowledged that loosening credit leads to higher housing prices. My point, which I have made over and over again and which you have done absolutely nothing to rebut, is that the financial crisis must have been created by systemic problems throughout the financial sector, and you have absolutely no explanation for how “bad ideology” spread everywhere. I would elaborate further but I’ve already written several detailed comments in this thread, none of which you’ve responded to in a substantial way.
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