A fable for our times
The WSJ has an op-ed piece which seeks to demonstrate that it was not just banks that caused the credit crisis. It begins:-
Once upon a time, in the land that FDR built, there was the rule of “regulation” and all was right on Wall and Main Streets. Wise 27-year-old bank examiners looked down upon the banks and saw that they were sound. America’s Hobbits lived happily in homes financed by 30-year-mortgages that never left their local banker’s balance sheet, and nary a crisis did we have.
Then, lo, came the evil Reagan marching from Mordor with his horde of Orcs, short for “market fundamentalists.” Reagan’s apprentice, Gramm of Texas and later of McCain, unleashed the scourge of “deregulation,” and thus were “greed,” short-selling, securitization, McMansions, liar loans and other horrors loosed upon the world of men.
Now, however, comes Obama of Illinois, Schumer of New York and others in the fellowship of the Beltway to slay the Orcs and restore the rule of the regulator. So once more will the Hobbits be able to sleep peacefully in the shire.
This is not reality of course, though it is the tale of fantasy being woven to explain the crisis to Main St, USA.
After a useful discussion of some of the regulatory shortcomings the article concludes:-
We could cite other Washington policies, including the political agitation for “mark-to-market” accounting that has forced firms to record losses after ratings downgrades even if the assets haven’t been sold. But these are some of the main lowlights.
Our point here isn’t to absolve Wall Street or pretend there weren’t private excesses. But the investment mistakes would surely have been less extreme, and ultimately their damage more containable, if not for the enormous political support and subsidy for mortgage credit. Beware politicians who peddle fables that cast themselves as the heroes.
Adam’s emphasis. In the USA, the UK, Australia and the UK we have a house ownership culture probably unlike that in many if not most other countries. In much of Europe long term renting is common.
Our politicians tie themselves in knots over making it easier for people to buy houses. They manipulate interest rates and other factors to enable this.
We see in NZ a lot of press on how NZ has a high level of personal debt. Much of this is related to mortgage finance, which was fuelled by borrowings on the international money markets. Our government like many is fixated on mortgage rates, possibly to the detriment of the overall economy.
It is relevant to consider in all the commentary the role of government in enabling the crisis. In NZ we cannot sit smugly by. Whilst perhaps not involved in the excesses of elsewhere our government and regulators are not blameless. They too should be actively considering what should be done.
Domestically we have only to look at the appalling record of the finance companies, which enabled in many cases credit to be given to poor quality borrowers.
Time for a rethink.
Later, a further thought
It was not until he looked again at the first paragraph of the last extract above that Adam began to wonder about another factor in all this. That factor is the implementation of IFRS. International Financial Reporting Standards were brought in to cope with the fallout from various earlier scandals such as Enron. Could it be though that they have contributed to this mess? Have regulators and others in seeking to deal with one set of problems effectively created another set?
Adam needs to think about this some more, so maybe another post in a while.
What Enron created was the accounting debacle thats part of the problem. This was “mark to market”. The example I’ve seen is that banks lent money on houses and recorded the asset value at the time.. then the houses dropped in value and under mark to market the value of the assets had to be dropped. However, the homeowners still carried on paying their mortgages at the same rates, ie, the cash flow remained the same to the bank. Unfortunately the banks had to make up the loss in asset value under mark to market by more borrowing in an increasingly difficult environment.
Then too, under Basel 2 rules, banks had to assess risks in lending to some homeowners and carry sufficient equity to cover the risk. This gave unscrupulous banks an incentive to minimise risk so that less equity (and thus costs of borrowing) had to be carried.
All up, banks would have had to scramble to get their depreciating asset values down to mark to market and cover themselves for the extra costs of doing so.. problem being the assets just kept devaluing even if the annual cash flow from mortgages stayed good.
Still, you can’t dodge the fact they lent far too much and probably way below the going interest rates.
Down here we’ve had the mixed blessing of having very high initial interest rates, and even though house prices have dropped we have the liklihood of interest rates falling in tandem (we hope).
JC