By way of Mark Thoma and Simon Johnson I was led to this set of slides by Daron Acemoglu, from a presentation at the ASSA meetings in Denver.
The slides are titled "Thoughts on Inequality and the Financial Crisis." There is some hard evidence in there, but Acemoglu is mainly throwing out some ideas for discussion. A key aim of his is to debunk some ideas that you can find in Rajan's book, and in this "pre-report" from the apparently-dissenting Republican members of the Financial Crisis Inquiry Commission (FCIC). Those people think that an important cause of the financial crisis was the proclivity of the government to do things for the poor by way of credit market intervention, in particular through the Community Reinvestment Act of 1977 (CRA), and the GSEs (Fannie Mae and Freddie Mac). I discussed some of these issues here (learned some things too - see some of the exchange in the comments section and a later post on CMHC).
As Acemoglu points out, it's hard to find evidence that the US government has been particularly favorably disposed to poor people during the last few decades. As most economists are well aware, the dispersion in income in the US population has increased, and Acemoglu summarizes the research results as telling us that this is mainly due to "supply, technology, and trade." Here, I think he means scarcity of particular skills, technological change that has increased the skill premium, and import competition in goods that are low-skill intensive. Changes in some government policies may indeed have favored rich people, particularly 1990s welfare reform and changes in income tax rates in the second Bush administration, but for the most part the changes in the income distribution appear to be driven by the effects Acemoglu mentions.
Now, what bothers Acemoglu are some ideas he has about what is going on at the very top (i.e. above the 99th percentile) of the income distribution. Essentially the idea is that, even in a democracy, money is power, as money buys politicians. Too much wealth at the very top only perpetuates itself, as the very wealthy have too much power to relax regulatory constraints in ways that allow them to prosper at the expense of everyone else. The hypothesis here is that what is going on at the very top of the income distribution is related to deregulation (in particular of the financial industry). This deregulation is seen as essentially issuing licenses to steal. For example, the regulatory loophole that permitted mortgage originators to make loans to low-income people who were incapable of ultimately meeting the loan payments, with those originators then selling the loans and making off with the profits was, in this view, essentially a social waste. Income was transferred from poor to rich, more houses were built than should have been, and the borrowers and the ultimate holders of the mortgages were left to sort out the losses and pay the legal fees.
Acemoglu certainly has a point. While Rajan has some interesting things to say about Fannie Mae, Freddie Mac, and the CRA, for example, it seems his political economy story is wrongheaded. However, Acemoglu seems to want to claim that the thrust of federal government policy was to "marginalize" the GSEs, and I don't think that is correct. Indeed, Fannie and Freddie are part of the phenomenon he is discussing. Fannie and Freddie were granted tax advantages and implicit (now explicit) government guarantees that gave them a cost advantage over private sector competitors. In fact, one could argue that it was the Fannie/Freddie cost advantage that drove the private sector to the only profitable game in town - risky mortgage lending. Further, the huge growth in Fannie and Freddie, given their implicit subsidy, created institutions with a huge amount of power, and they used that power to lobby Congress for favors. We can think of Fannie and Freddie as being run by another set of rich people at the top of the income distribution.
In a recent interview, Bernanke pointed to the recent performance of the stock market, and in particular speculative small-cap stocks, as proof of QE2's effectiveness.ReplyDelete
One interpretation is that the Fed sought to offer speculators (financial firms, hedge funds) an arbitrage opportunity in stocks, and they responded beautifully. The main channel for monetary policy today seems to be the offering of such arbitrage opportunities to the financial class. For instance, in 2002, it was perhaps not low interest rates that sparked a "bubble", but the signal from the Fed that rate volatility would decline substantially ("extended period"). This signal told investors that it was profitable to substantially increase maturity and liquidity risk, and the financial system became fragile as a result.
The enrichment of arbitrageurs has emerged as a "necessary" dynamic of monetary policy. The Fed seems blind to the price distortions, systemic risk, and market imperfections (rent-seeking through political influence) that result from this. I wonder why, because the tools of economics lend themselves to identifying these distortions. IMO, they seem to be willfully refusing to employ those tools.
Income inequality is not a question of morality, but of market imperfections that lower overall welfare. I appreciate that, as a conservative economist, you are willing to adopt this (more intellectually rigorous) perspective.
"In fact, one could argue that it was the Fannie/Freddie cost advantage that drove the private sector to the only profitable game in town - risky mortgage lending."ReplyDelete
Wait, so we're to believe that the bankers who could have invested in any area of the economy that they wanted, were forced to invest in risky mortgage lending (derivatives) not because it was highly profitable, but because normal mortgage lending wasn't, nor was any other area of the economy?
Does this also apply in countries like Latvia, Spain, etc?
Do you have any evidence for this?
It couldn't just be pure, unadulterated greed? You know, like conventional economics, where one would normally say that a business saw a market that was highly profitable and decided to supply a product/service to said market?
This sure does seem like a roundabout way to say "somehow its lending to poor people that caused this..."
Are you further saying that if fannie and freddie did not exist, these companies would have ignored this profitable market? Everyone would have left it alone? Really?
"For example, the regulatory loophole that permitted mortgage originators to make loans to low-income people who were incapable of ultimately meeting the loan payments, with those originators then selling the loans and making off with the profits was, in this view, essentially a social waste. Income was transferred from poor to rich, more houses were built than should have been, and the borrowers and the ultimate holders of the mortgages were left to sort out the losses and pay the legal fees."ReplyDelete
Assuming nobody knows that these are mortgages that are not to by paid. Which, back than, many people actually didn't know. Either it was fraud or it 'just happened'. The 'regulatory loophole' is like 'the regulator should have known that these aren't going to be paid'; so should the buyers.
Yes, very good point. The Fed's attempt to shift risk away from the private financial sector can ultimately make financial institutions more fragile, and it has consequences for the income distribution too.
"It couldn't just be pure, unadulterated greed?"
You haven't got this yet. There is good greed (Adam Smith), and bad greed (theft). What I was thinking about here, specifically, was that a growing Fannie and Freddie had absorbed much of the market in conforming mortgages. Private intermediation could not expand into that market and make a profit, given the Fannie/Freddie cost advantage. To expand, they have to take the piece of the mortgage market that Fannie/Freddie had left untouched, which was alt-A. They're making money hand-over-fist at that, Fannie and Freddie see that, and they want a piece of it too, which gets them into trouble and they had to be taken over by the government and bailed out.
Yes, the regulators should have known what was going on and controlled it. Suppose I am a low income buyer. Maybe this is my first mortgage. Compared to me, the lender is a financial wizard, as far as I know. If the lender is willing to lend me the money, why shouldn't I be confident that I can actually meet the terms of the loan. Did you read all the fine print the last time you refinanced your mortgage?
I don't understand your answer to SM. Do you claim that private intermediators would not have expanded into the alt-A market - thereby neglecting an opportunity for 'making money hand-over-fist' - if it wasn't for Fannie/Freddie occupying much of the conforming mortgages market?ReplyDelete
"I don't understand your answer to SM. Do you claim that private intermediators would not have expanded into the alt-A market - thereby neglecting an opportunity for 'making money hand-over-fist' - if it wasn't for Fannie/Freddie occupying much of the conforming mortgages market?"ReplyDelete
I'm curious about this too.
Sure, if A is unprofitable for me and B is profitable, I'll do B. If A is profitable and there nothing different about B, I'll still do B.ReplyDelete
You answer my question with:"Sure, if A is unprofitable for me and B is profitable, I'll do B. If A is profitable and there nothing different about B, I'll still do B."ReplyDelete
But then why do you write in the piece that:"one could argue that it was the Fannie/Freddie cost advantage that drove the private sector to the only profitable game in town - risky mortgage lending"?
Here's a better way to put it: Fannie and Freddie, with their government-granted cost advantage, expanded in a big way into the low-hanging-fruit section of the mortgage market. Given my characterization of Fannie and Freddie as slothful rent-collectors, they were not the innovators in the industry. The innovators - institutions in the private sector - saw a profit opportunity in alt-A lending, and took it. Apparently some of the profit opportunities they were pursuing were in fact highly risky and in some cases close to theft, if not the real McCoy. Fannie and Freddie, taking umbrage at the fact that any private sector mortgage market participant could be growing, wanted a piece of that action too. The rest is history. Now, suppose that the financial crisis had not happened (I know, it's a strange counterfactual). What do you think would have happened in the mortgage market? What could well have happened is that Fannie and Freddie would have encroached further on this new activity and been successful in edging out the private competitors. Each time an innovation comes along, Fannie/Freddie imitates, and wins out because of its cost advantage. Is that better?ReplyDelete
I think that the other "anon" and "AH" understand, and could restate more clearly, what i was getting at. For a minute there i thought everything i had learned in econ 101 was wrong...ReplyDelete
Now, my question is this: did it matter if private competitors undertook bad activity X or if quasi public competitors undertook bad activity X? Is you argument that if companies are going to undergo bad activities, they should get to keep more of the profit of said activity?
And was it the fact that said activity was indeed bad that was the underlying problem, or which competitor that did it?
Let's try one more counterfactual: fannie and freddie didn't exist (like...say in foreign countries)...how does everything turn out? Any different? Instead of a couple hundred billion to fannie/freddie, we make the checks out to banks instead - because we all agree the same mortgages get written, right? It seems to me that fannie/freddie received no different of a backstop than every other bank shy of lehman. I don't see the point of the argument here: fannie/freddie took some profits from some private companies, and were left holding the bag - until the gov't paid for the bag, which it would have done no matter what to prevent "great depression II." Is this not correct?
Yes, the basic problems with Fannie/Freddie and the large banks are closely related, for example there is a moral hazard problem associated with too-big-to-fail which is endemic to both, and a failure of the regulators to impose sufficiently stringent capital requirements. Countrywide Financial originated loans and passed them on to private financial institutions that created mortgage-backed securities (MBS), and the GSEs had a close relationship with Countrywide Financial. I think what you are pointing out is that our financial problems were systemic - it's hard to separate Fannie/Freddie from the private sector problems - and I agree completely. I've stated before that trying to separate good guys from bad guys here is impossible. It's not a matter of government bad, private good or vice-versa.