Uninformed Opinions About The Credit Crisis

Megan McArdle advises Matt Taibbi to stop. And has some good advice for people who only tuned in to the financial world during the credit crisis:

No one who did not know what a CDO was before the crisis should be opining as to the causes or the possible solutions. And anyone who tells you that they understand exactly why this happened, why we got this crisis instead of the dollar crisis we were expecting, and what kind of regulations will unquestionably fix it, is definitionally too ignorant to be opening their mouth.

The funny thing is Taibbi ranting about the institutional market for securities backed by bad loans…while at the same time refusing to address the bad loans themselves except to deny they had any role. That failure of basic logic alone is hilarious.

The overextension of housing credit, which formed the collateral for the various instruments whose loss of value set off so many other dominos falling, was, by definition, at the root of the crisis. Now, was the root of the crisis the only cause, or the only thing we ought to avoid repeating? Are there other, second-order aspects of the system that made it more vulnerable to the contagion from loans to un-credit-worthy borrowers based on overvalued real estate? Of course not, and as McArdle says, the fact that we can piece together some significant contributors to the crisis does not equate to understanding fully why it happened.

Then again, while I understand McArdle’s call for a cool, academic assessment of the multiple factors involved after we get more data, that approach is entirely impractical in the middle of a contested election, in which both sides are naturally going to have to answer voter questions about what happened and why. It would be political malpractice for Republicans not to make the (accurate) point that the roots in the lending/housing market are the part of all this in which bad public policy played the most direct role in distorting the market away from its natural equilibrium. And it’s likewise a slam dunk to point out that had Republican-led legislative efforts to rein in the GSEs not been stymied in the 2001-2005 period, the situation would have been, at a minimum, much more tractable to deal with, and that Democratic opponents of such efforts had longstanding financial and ideological reasons to oppose them.I’ve been meaning for a while to do a longer post on the inevitable (even if McCain wins) mania for more regulation, although I could just as easily refer you to McArdle’s entire blog for that. Here, for example, she points out the obvious fact that regulators are human and not generally wiser than the businesses they regulate:

Nor is there any particular proposal for preventing that institution from falling prey to the same forces that grip the regulated industry. I have said it before, but it is worth repeating: the regulators became overconfident in the same way, and for the same reasons, that the bankers became overconfident. Just as a long and unusually rosy period in the housing market convinced the bankers that they had gotten better at pricing credit risk, a long period without a large bank failure persuaded the regulators that they had gotten better at regulation. They believed that their computer models, and an improved understanding of how markets and the economy worked, would allow them to see problems in time and halt them. Obviously, they were wrong.

Regulators, no matter how diligent or well-staffed or well-funded, never have

(1) The same degree and timeliness of access to information about a business and its daily operations as the people who run it and interact continuously with its employees; or

(2) The same incentive to ensure the continuing profitability of the business as the people who draw their income from it.

Also, while you do get good people who go into government for all sorts of reasons, people who have the specific skill set of being really shrewd observers of financial markets are probably the people least inclined to take far lower-paying jobs regulating those markets than making money in them; draw what conclusions you will about the ability of the regulatory agencies to be all-wise and all-seeing under the best of circumstances.

Now, if you are talking about regulating an industry to keep it from unscrupulously ripping off other people outside their businesses, at least you have an argument about whether people with less competence and less information are nonetheless properly charged with restricting the business’ operations. But the crucial issue in debating the second-order aspects of the credit crisis (i.e., why institutions let themselves get overexposed to risks derived from bad loans), at the end of the day, is whether regulators were better situated to protect the interests of the financial industry itself than the people who worked in it. You should expect some skepticism about that kind of argument.