A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Sunday, January 10, 2010

Week links and paragraphs

Walk away from your mortgage
from Roger Lowenstein at the New York Times
And given that nearly a quarter of mortgages are underwater, and that 10 percent of mortgages are delinquent, White, of the University of Arizona, is surprised that more people haven’t walked. He thinks the desire to avoid shame is a factor, as are overblown fears of harm to credit ratings. Probably, homeowners also labor under a delusion that their homes will quickly return to value. White has argued that the government should stop perpetuating default “scare stories” and, indeed, should encourage borrowers to default when it’s in their economic interest. This would correct a prevailing imbalance: homeowners operate under a “powerful moral constraint” while lenders are busily trying to maximize profits. More important, it might get the system unstuck. If lenders feared an avalanche of strategic defaults, they would have an incentive to renegotiate loan terms. In theory, this could produce a wave of loan modifications — the very goal the Treasury has been pursuing to end the crisis.

No one says defaulting on a contract is pretty or that, in a perfectly functioning society, defaults would be the rule. But to put the onus for restraint on ordinary homeowners seems rather strange. If the Mortgage Bankers Association is against defaults, its members, presumably the experts in such matters, might take better care not to lend people more than their homes are worth.
Bernanke Blames Weak Regulation for Financial Crisis from Catherine Rampell at the New York Times
ATLANTA — Regulatory failure, not low interest rates, was responsible for the housing bubble and subsequent financial crisis of the last decade, Ben S. Bernanke, the Federal Reserve chairman, said in a speech on Sunday. Bernanke is expected to be reconfirmed this month as the Federal Reserve chairman.

Mr. Bernanke’s remarks, perhaps his strongest language yet assessing the roots of the financial crisis, came as he awaited confirmation for a second term as Fed chairman and as he sought greater regulatory authority from Congress.

“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,” Mr. Bernanke said in remarks to the American Economic Association.
Bernanke still has no clue. In spite of trillions of dollars of Fed backstopping, the economy is not fixed. He needs to go.

Bernanke’s Ivory Tower Doesn’t Have a Mortgage from Caroline Baum at Bloomberg
You can almost hear the collective sigh of relief emanating from the Federal Reserve Board in Washington, and the nearby offices of Alan Greenspan, to Fed chief Ben Bernanke’s elegant, econometric argument that low interest rates didn’t cause the housing bubble. The Fed, in other words, is guilty of one count of regulatory oversight failure. As to the charge of using interest-rate policy to inflate the housing bubble that burst and destabilized the entire financial system, the defendant is not guilty.
In a speech to the American Economic Association’s annual meeting in Atlanta last weekend, Bernanke said the linkages between monetary policy and home prices were weak. His conclusions, based on econometric models and statistical analysis, may resonate with his AEA audience. For the rest of us, they leave something to be desired. ...

It’s always easier to start with a desired conclusion and retrofit a model or equation to prove it.

Rubinomics not at fault according to its author from Robert Rubin at Newsweek
To determine the lessons of the crisis and the necessary reforms, we must first understand what caused it. My discussion here relates to the United States. About four years ago, a well-known London investor said to me that the only undervalued asset in the world was risk. I had the same view, as did many others, and often said that markets, including credit, had gone to excess and that would probably be followed by a cyclical downturn—perhaps a sharp one—though the timing, as always, was unpredictable. But that's not what happened. Instead, these excesses combined with other powerful factors that occurred at the same time: low interest rates that led investors to an unsound reaching for yield; massive increases in the use and complexity of derivatives that heightened systemic risk in stressed markets; misguided and powerfully consequential AAA ratings for many subprime-mortgage derivatives; stagnant median real wages and rising housing prices that led consumers to overborrow to maintain living standards; a subsequent dramatic decline in housing prices; lax and often abusive mortgage practices; overleveraging by financial institutions and deterioration in the quality of their asset acquisitions; and, as time went on, greatly tightened credit availability, growing unemployment, and a falling stock market.

It was this extraordinary combination that led to the worst financial crisis in 80 years. In addition, there has long been a disproportionate focus on the short term in corporate earnings, markets, compensation, and other matters that contributed to this dangerous mix.

While some people saw one or more of these factors, virtually no one involved in the financial system—whether institutions, investors, regulators, analysts, or commentators—recognized the breadth of forces at work or the possibility of a megacrisis, and this included the most experienced among us. More personally, I regret that I, too, didn't see the potential for such extreme conditions despite my many years involved in financial matters and my concern for market excesses.
We at Demand Side regret Rubin's construction of the galleons of the disaster, the huge megabanks and his authorship of the charts to the edge of the Earth and his powerful assistance to the captains in assessing the shoals as open sea.

Let the Mea Culpas begin, part 1 from L. Randall Wray at Economic Perspectives from Kansas City
Don't hold your breath for an apology from Summers, who never owns up to his mistakes, ranging from his proposal to use developing nations as toxic waste dumps to his argument that females suffer from congenital handicaps that render them incapable of doing science (here and here).

Still, with three out of the four (Greenspan, Bernanke, Rubin, albeit half-heartedly) acknowledging errors, this could indicate a New Year's trend. Next we can hope that the University of Chicago—the institution most responsible for producing the theories that guided our misguided policymakers—will apologize for its indiscretions. That could set an example for all mainstream economists who, as the Queen pointedly put it, failed to foresee the crisis.

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