So now we're ready to talk about
the crisis of 2008
and
I think people are going to argue about
sort of the causes and how
the crisis of 2008 unfolded
they're going to argue about that for years
I'm maybe going to talk about a few of the narratives
I'll emphasize the one that I prefer
and the one that I prefer is actually the one that takes what
came out of the S and L crisis
that is belief in securitization
mark-to-market accounting
and risk-based capital
and all of those
helped contribute to,
they didn't necessarily cause,
the crisis of 2008
that is they all kind of made it worse.
First of all securitization:
the thinking was that securitization
kind of got rid of the interest-rate risk and mortgages
because the savings and loans basically
had failed because of interest-rate risk
they were borrowing short-term deposits
that had regulated interest rates
and they were lending
these long-term mortgages
so the idea is that somehow
the capital markets
would take care of interest-rate risk
interest rate risk
that was the thinking
so the regulators definitely favorite securitization
and that risk-based capital would take care--
would ensure prudent banking
that is if you told banks
that they would have to hold more capital against risky assets
they would select less risky assets
And finally the mark-to-market
was to try to protect regulators from
not being able to close a bank or savings and loan
because the bank is solvent on historical cost basis
even though it's truly insolvent
So these seemed to be good solutions
They all came to be problems
The risk-based capital
ultimately--
the low-risk assets under risk-based capital
came to include
Freddie and Fanny securities
so that allowed them to expand
and AAA-rated private label securities
and that allowed the subprime market to expand
so we have this explosion in mortgage credit
in the '90s to 2000
so we have a big increase in mortgage credit
and it expands to -- and the subprime market
in particular really expands
and that's due in part to the innovation of being able to put subprime mortgages
into these AAA-rated private label securities
So we have this--
We have a combination of risk-based capital
and securitization
and that pushes things forward
and then
in the middle of the crisis
the mark-to-market accounting turned out to be very
pro septical, that is
as long as the securities are doing well
the market can expand, people are showing
good amounts of capital on their books
and so people can--
so things are good
and then when the market starts to turn the other way
then the companies that have these securities on their books
have to sell them
and that in turn drives down the market value
and that in turn because of the risk-based capital regulations
and the mark-to-market accounting means that people have to then--
they have to then reduce their holdings of the seurities
which drives down the market by more
and you've got this kind of vicious cycle
of declined values
and that was really kind of in the middle of things in 2008
that was what really caused a lot of problems
so mark-to-market accounting was not the regulators' friend
during the-- at kind of at the height of the crisis so to speak
so these three policies that were introduced to kind of
prevent or rerun the savings and loans crisis
were all somewhat dysfunctional
in terms of what happened in 2008
so there's that
now the policy response was sort of interesting
the policy response I think was
based on a narrative
and I'm talking about the Dodd-Frank legislation as an example of the
policy response
was based on a narrative that said, first of all, that one of the problems
was an outbreak of predatory lending
kind of a problem of excess greed
so we needed a consumer financial
protection board
and you have to be a little bit careful about that
because a lot of the push for expanding to lend to people who we
now believe were not qualified to
have mortgages
well there was a lot of pressure from Congress and from the politicians
to broaden the lending base to lend to more people and increase
home ownership and so on
and there was some formal
regulatory pressure
in the form of community
lending requirements (CRA)
and also some affordable housing goals
for Freddie Mack and Fanny May
now there's a lot of controversy
over what the effect of those was
and whether private firms would have
gone after those markets anyway
but in any case there was certainly
no pressure as the housing bubble
was inflating, there was no political
pressure being placed on anyone
to curb their lending
and then
another part of the narrative
is that a lot of this that regulators
couldn't see the problems coming
they were building up in parts of the
financial system that weren't being
closely watched
The notion is that regulators
going forward will be watching more
carefully the risk
although what we've seen is that regulators at
the time thought they were watching risk
and had it under control and they just thought that
in getting securities out in the capital market and getting
mortgages loans off the books of the banks was kinda sufficient to manage risk
from a regulatory standpoint
so it was kind of, it wasn't like they weren't trying to manage risk,
it's just they, they weren't kind of looking in the right places.
So the main lesson I want you to take away from these talks
is that if you just look backwards
you can be convinced that you're solving a problem
we've solved the problem of the Great Depression
but ultimately that built up into the problems that created
the savings and loan crisis
and then the things that we thought solved the savings and loan
crisis contributed to and maybe even
caused the crisis of 2008
So you have to be a little
worried about a notion,
and again, the narrative of
Dodd-Frank is that somehow,
we can prevent ever having to
bail out, prevent ever having this kind of crisis
and I think the evidence if you look
at the long-term perspective
the evidence that we can through
regulation or smarter policies
prevent these things is not good
and is something that I would
worry about
I would be more inclined to try to have
a financial situation that's easier to fix
rather than claiming that you can make it hard to break
or impossible to have a crisis
so anyway
that's my story on the crisis of 2008
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