"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Monday, June 7, 2010

Really great links - Krugman on solvency - Econbrowser: recovery sluggish - Raghu Rajan - Structural crisis - Dilbert

Paul Krugman - Solvency - "As you can also see, by the debt-and-deficit criteria the US, UK, and (as you can’t see) Japan look similar enough to the crisis countries that if you didn’t know better, you might expect them to be in the same boat.
        But they aren’t. As of right now, the interest rates on 10-year bonds are 3.59% in the UK, 3.36% in the US, 1.29% in Japan. CDS spreads for Japan and the UK are only about a third of the level for Italy.
        So what does one make of this? One possible answer is, just you wait — any day now there will be a Wile E. Coyote moment, the markets will realize that America is Greece, and all hell will break loose. The other answer is to note that all the crisis countries are in the eurozone, while the US, UK, and Japan aren’t — and to argue that having your own currency makes all the difference.
        I’ll choose door number 2."

James Hamilton - Current economic conditions - "Yes, we're still in the economic recovery phase, and yes, it still looks pretty sluggish."

Raghu Rajan - Response to Paul Krugman - "I reproduce Paul Krugman’s “econometric” claim above that Fannie and Freddie did not help cause the crisis above (I do not claim the Community Reinvestment Act was a big factor). I respond only because I have received hate mail from his followers. Paul is, of course, a great theoretical Nobel-prize-winning economist, so his attacks must be taken seriously (and I did take his trade theory classes at MIT, in the interest of full disclosure). Unfortunately, much of the “Fannie and Freddie did not contribute to the crisis” battalion makes arguments that have serious holes. Since these arguments are so prevalent they need to be rebutted again and again (the claimed unwillingness to listen to argument can be played on both sides).
        The key graph in Paul’s argument is Figure 4. He claims that restrictions on Fannie and Freddie starting in 2004 kept their share of originations of total residential mortgage originations down, even while housing prices inflated. But this is irrelevant to the question. What we care about though is the amount of Fannie and Freddie’s originations in the sub-prime residential mortgages. And from every source I have seen, these took off precisely in 2004. Indeed, as I argue in my book Fault Lines, in the period 2004-2006 these two giants purchased $ 434 billion in sub-prime mortgage-backed securities. A measure of the size of these purchases is that in 2004, they accounted for 44 percent of the market for these securities. Calomiris and Wallison argue that Fannie and Freddie’s arms were twisted into doing more of this kind of lending starting in 2004 precisely because Congress had them in a vice because of the scandal."

Barry Ickes - Structural Rigidities and Financial Crisis - "Sometimes it is hard to understand the connection between structural rigidities and financial crises.
        The specific example is rent control. This is quite severe in Portugal:
        José Gago da Graça owns a Portuguese real estate company and has two identical apartments in the same building in the heart of Lisbon. One rents for €2,750 a month, the other for almost 40 times less, €75.
        The discrepancy is a result of 100-year-old tenancy rules, which have frozen the rent of hundreds of thousands of tenants and protected them against eviction in Portugal.
        What is the connection to the financial crisis? Well, these rules limit production of rental housing, and thus force people to purchase rather than rent housing.
        The post-revolution rules helped protect tenants, but also led to a chronic shortage of rental housing. This, in turn, persuaded a new generation of Portuguese to tap recently into low interest rates and buy instead — often in new suburbs — thereby exacerbating the country’s mortgage debt and leaving Portugal with one of Europe’s lowest savings rates, of 7.5 percent.
        When the opportunities to borrow at low rates -- due to the euro -- presented themselves, Portuguese households took advantage. Rather than rent and save, households were pushed, by rent control, to borrow and purchase. That would not be so bad if the price of housing was not experiencing a bubble."

Scott Adams - Dilbert - "Let's talk about morality. Can you justify owning stock in companies that are treating the Earth like a prison pillow with a crayon face? Of course you can, but it takes some mental gymnastics. I'm here to help.
        If you buy stock in a despicable company, it means some of the previous owners of that company sold it to you. If the stock then rises more than the market average, you successfully screwed the previous owners of the hated company. That's exactly like justice, only better because you made a profit. Then you can sell your stocks for a gain and donate all of your earnings to good causes, such as education for your own kids."


  1. Professor Rajan's rejoinder to Dr. Krugman has a serious problem.

    He argues that it is crucial to analyze Fannie and Freddie's "originations" (by which I assume he means their share of purchases of individual mortgages, becaus they do not originate loans). However, he disproves his own point by highlighting Fannie and Freddie's purchase of sub-prime mortage backed securities which, by definition of course are NOT Fannie and Freddie "originations."

    Thus, the sub-prime problem, as it related to Fannie and Freddie, was that -- as entities which needed to compete with other lenders to raise capital -- they too participated in the secondary market for sub-prime loans. Accordingly, it was Fannie and Freddie in their private market roles which contributed to the crisis, not their public role in buying individual conforming (i,.e., non sub-prime) loans.

  2. Thank you for your comment.
    Fannie and Freddie had a huge advantage in competing with other lenders to raise capital - they had implicit government backing, which has become more explicit since those days.
    Fannie and Freddie channeled their implicit govt backing subsidy into subprime MBS.


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