It’s Christmas Time in the Citi
You know how some guy supposedly said, "Democracies survive until the citizens realize they can vote themselves money from the treasury?" I’d like to find that person and punch him in the face.
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Comment by ajay —
November 25, 2008 @ 7:53 am
No one’s actually been able to find out who originally said that, you know.
http://lorencollins.net/tytler.html
Apart from anything else, it’s manifest nonsense. There are very few examples in history of democracies collapsing – even for the stretchiest definition of “democracy” and “collapsing” – and none of them are obviously the result of ever-greater government social spending. (Classical Athens? Weimar Germany? Allende’s Chile? Masaryk’s Czechoslovakia?)
“Democracies generally survive until they get overthrown by a massively superior outside aggressor” would seem to be a better way of putting it.
If you want to argue that excessive government spending will bring about the collapse of democracy, go for it, but find a different way to do it.
Comment by joe from Lowell —
November 25, 2008 @ 9:25 am
Good on ya, ajay.
There are very few examples in history of democracies collapsing – even for the stretchiest definition of “democracy†and “collapsing†– and none of them are obviously the result of ever-greater government social spending.
Also, the Road to Serfdom? Never happened. USSR, Nazi Germany, China, Vietnam, Cambodia, Laos, Niaragua, Cuba – not a single one of the totalitarian states in history got that way by gradually morphing from a democratic republic into a totalitarian dictatorship via the growth of a technocratic class administering an ever-expanding welfare state.
Comment by Carlos —
November 25, 2008 @ 9:52 am
Except in fiction. Many libertarians use fictional examples as if they had evidential weight. Ayn Rand and science fiction are the favorites, of course — Vernor Vinge had a forest service morph into the Almighty State in one of his books, which I’m sure had the neckbeards nodding sagely — but not exclusively those two. Hell’s bells, Glenn Reynolds once used a moonlight and magnolia passage from an Andrew Lytle novel as support in his communitarian gun rights paper. (Which makes two people who have read Lytle’s fiction in the last twenty years, although maybe Reynolds skimmed, as seems to be his wont.)
Comment by Tim —
November 25, 2008 @ 10:07 am
Wait. Did I miss the vote where one of the choices was “Give Citibank a zillion dollars, Yes/No”? Or does “demo” = “pluto” for all values of “cracy” now?
Comment by Jim Henley —
November 25, 2008 @ 12:04 pm
Tim: Is “punch him in the face an encomium in your fandom?
Comment by Cryptic Ned —
November 25, 2008 @ 12:31 pm
I mostly agree with comment 2. None of those situations involved a welfare state, except Cuba. Also, communism is not the same thing as a welfare state.
Unless he was somehow being sarcastic.
Comment by ajay —
November 25, 2008 @ 12:40 pm
Vernor Vinge had a forest service morph into the Almighty State in one of his books, which I’m sure had the neckbeards nodding sagely
No, I can seriously see that happening. The first step would be the rise to power of a charismatic Head Ranger.
Next, a massive and hate-filled propaganda campaign aimed at stirring up hatred and fear of Der Ewige Bar, the Eternal Bear, a sinister and omnipresent threat, ever coveting our pic-a-nic baskets.
With the masses whipped into a state of unthinking anti-ursine frenzy, the Rangers could easily make the case for draconian anti-bear powers. You could write a book about it. The Trail to Serfdom.
Comment by ajay —
November 25, 2008 @ 12:42 pm
I mostly agree with comment 2. None of those situations involved a welfare state, except Cuba
The Cuban Revolution didn’t involve a welfare state either.
Comment by joe from Lowell —
November 25, 2008 @ 1:45 pm
Also, communism is not the same thing as a welfare state.
TRTS postulates that totalitarian governments (communist and fascist governments get blended together under that heading) come about through the expansion of the welfare state, which gradually usurps individual rights in the name of the common good, and democratic accountability in the name of rational governance by an enlightened elite.
It’s the whole “they’re going to start making you exercise at gunpoint like in 1984 if we adopt a public health insurance system” argument.
Comment by Jim Henley —
November 25, 2008 @ 1:50 pm
Well, no, I don’t think it does. Specifically it talks about central planning of the economy that destroys the price system, not public health insurance and old-age pensions and the like. It is mostly libertarians and conservatives who came after Hayek who tried to generalize his anti-central-planning arguments into anti-safety-net or social-welfare ones.
Interestingly, Ayn Rand rejected Hayek’s work because, she said, that once you accept the sorts of social-welfare measures Hayek countenances, you accept, in principle, any state intervention. I think she was wrong, but it gives you an idea of the distinctions among anti-socialist thinkers of the middle half of the 20th Century.
Comment by joe from Lowell —
November 25, 2008 @ 2:28 pm
Well, what does and does not fit under the heading “central planning” is much debated. Some “faceless bureaucrat” is deciding how to spend your money whenever there’s a social welfare system.
But, yes, Hayek was talking about central planning, not just the welfare state, and I might have picked clearer language. Regardless, the point is, none of the totalitarian states came about through the expansion of the power of technocrats eating away at individual liberty. They were all produced by violent revolutions waged in the name of distinctly non-technocratic ideals.
Comment by Eric the .5b —
November 25, 2008 @ 2:47 pm
Mmm, true, vast spending hasn’t destroyed a modern democracy. Neither has military empire or voters’ religious fundamentalism, though, police cameras networks blanketing cities, or programs of inhumane detention and torture. If you stretch the definition of “modern” enough, slavery and genocide have been merrily carried out by democracies with no damage to that system.
If we want to go the ha-ha, none of your nightmare death-of-freedom-by-the-left scenarios have happened route, we have to acknowledge that the all the other death-of-freedom scenarios – even the “stealth one-party rule by voting machine manipulation” conspiracies some posters and commenters here were throwing around in 2004 – haven’t happened either.
Now, it could be democracies are infinitely robust and all those people who worry about losses of freedoms are just nitpickers angsting about the loss of their right to drink polluted water, as the current line goes. Every government action that appears to be chipping at freedom is just sort of harmlessly filing away at freedom, which is an ever-growing thing – a toenail of liberty.
Alternately, it could be that the voters and even people in office have resisted the damage attempted in response to worries about just these sorts of scenarios, and both have even occasionally managed to correct things a bit when the damage seemed obvious.
Comment by joe from Lowell —
November 25, 2008 @ 2:47 pm
You’re right, Jim, I’m letting the propaganda from Reason go to my head.
I completely elided the difference between a welfare state and central economic planning.
Comment by joe from Lowell —
November 25, 2008 @ 2:50 pm
Every government action that appears to be chipping at freedom is just sort of harmlessly filing away at freedom, which is an ever-growing thing – a toenail of liberty.
Wow, that’s awesome.
Alternately, it could be that the voters and even people in office have resisted the damage attempted in response to worries about just these sorts of scenarios, and both have even occasionally managed to correct things a bit when the damage seemed obvious.
Is this really a different point, though, or is it just the mechanism by which the “infinitely robust” democracy protects itself?
Comment by Eric the .5b —
November 25, 2008 @ 3:06 pm
I don’t get the anger though, Jim. I know the bailout was unpopular, but I sure don’t remember any of the government action leading up to this, from FDIC forward, being anything but supported by voters. I don’t think Bush reaped any public discontent by saying the government needed to make home ownership affordable to everyone – and that the private sector needed to get with the program.
I don’t see any value in pretending that what’s going on is all the work of those plutocratic bastards, even as every mainstream economist out there is going on about how it’s all terribly necessary every step of the way, and that the only quibbles are in the details.
Yes, this is staggeringly huge rent-seeking, but it’s rent-seeking that would be utterly impossible without damn fine, if unintentional, cover work being done across the political spectrum by people in and out of government.
(You know, for all the shit libertarians have gotten in these comments and some of your posts, Jim, about Reds using their rhetoric, you’d think the modern discipline of economics might be in for just a little criticism for the power they’ve given government and the benefits they’ve helped funnel to rent-seeking private interests.)
Comment by Thoreau —
November 25, 2008 @ 3:13 pm
I will say that among some libertarians (no, I’m not pointing fingers at any blogger or commenter here) there is a tendency to favor analyses in which differences of degree never, ever accumulate into differences of kind. Given that many aspects of markets are emergent phenomena, that seems like a foolhardy line of analysis. It does, however, lend itself to absolutism.
Comment by Eric the .5b —
November 25, 2008 @ 3:14 pm
It’s the difference between, “Damn those people who worry about dangers to freedom!” and “Damn, I worry about dangers to freedom.”
It’s the difference between a fairy tale of infinite robustness and trying to keep a system working – and perhaps being far more lucky so far than you want to think about.
Comment by Eric the .5b —
November 25, 2008 @ 3:23 pm
And the unwillingness to trust in correction mechanisms, even to the extent they work. Very few major government follies get entirely fixed, but many of the worst excesses get reined in now and then, when they get bad enough. Any welfare program will grow in scope and scale, but no democracy has collapsed under its welfare system before people started demanding reform.
Though, to be fair, “If this goes on…” worst-case scenario thinking isn’t remotely unique to any part of the political spectrum.
Comment by Eric the .5b —
November 25, 2008 @ 3:53 pm
And let’s be really blunt, Jim. Those home-owners unable to pay a mortgage outside of a bubble aren’t saying, “Yeah, fair cop, that was a bad idea, how do I get out of this safely?” any more than their lenders. No, they want help maintaining their untenable staus quo because they were cheated out of their God-given right to a cheap home that would eternally appreciate in value.
Voters might have opposed the bail-out, but they sure wouldn’t support letting those institutions and people suffer any consequences.
Comment by abb1 —
November 25, 2008 @ 4:07 pm
Should I be always be the guy who talks about Switzerland?
Most democratic – and yet least centralized.
Welfare state, yes – and yet there’s no socialism here. Not even a single-payer health care, no social security, no medicare, no medicate.
Everyone keeps a machine-gun in a closet – and yet no war since something like 1600s.
Mystery, huh.
Comment by dhex —
November 25, 2008 @ 4:11 pm
“Voters might have opposed the bail-out, but they sure wouldn’t support letting those institutions and people suffer any consequences.”
well, some of them have puppies!
sure some i-bankers have puppies too, but they’re rich puppies, and probably white.
Comment by Eric the .5b —
November 25, 2008 @ 4:19 pm
Could you be the guy talking about the relevance of a tiny country with a unique history to this situation?
Comment by Thoreau —
November 25, 2008 @ 4:40 pm
Eric-
Slippery slopes aren’t unique to any political ideology. But the phrasing I encounter among libertarians is more like “There’s no logical distinction between….” which is at least different in style from the slippery slope.
Comment by Picador —
November 25, 2008 @ 5:45 pm
Eric:
From the way you talk about “the modern discipline of economics” and “people in and out of government” “across the political spectrum” as distinct from “libertarians”, one might think that the chairman of the Federal Reserve during both the (Democratic) Clinton Administration and the (Republican) Bush II Administration wasn’t a huge, flaming, card-carrying Objectivist, libertarian, and personal friend of Ayn Rand’s.
The University of Chicago has remade “the modern discipline of economics” in the image of libertarian ideology, and has even succeeded in tainting many other disciplines connected to economics. This new conception of political economy has been embraced enthusiastically by both major political parties in America, if not entirely in its pure big-L Libertarian form, then at least as cover for the diversion of tax money out of social programs and into the pockets of their patrons in industry.
Comment by Eric the .5b —
November 25, 2008 @ 6:07 pm
Not sure how you mean, Thoreau, beyond the “any government spending beyond night-watchman stuff is socialism” types. Or do you mean those?
Comment by Avram —
November 25, 2008 @ 6:09 pm
Specifically it talks about central planning of the economy that destroys the price system
Speaking of which, has anyone else noticed that the unregulated credit default swaps market has destroyed (or at least seriously muddled) a whole lot of pricing information?
Comment by Eric the .5b —
November 25, 2008 @ 6:14 pm
Picador, I’m intrigued that the guy running the Fed in your alternate dimension had an Ayn Rand fetish, too.
Did your John Travolta also have a comeback in the 90s?
Comment by matthew hogan —
November 25, 2008 @ 6:15 pm
I think this discussion went off the rails at the start.
As a non-card carrying libertarian (though who doesnt like Rand), the question of whether democracy is preserved is a minor one.
As noted democracies, even as they expand and flourish –
exterminate ethnic groups on desired land
establish religions funded by tax and impose their sectarian morality
jail gays for doing consenting adult stuff
jail and ruin thousands for self-entertainiment and medication
detain citizens during wartime because their ethnic group is the enemy overseas
jail or harass political undesribles
elect Hitler by pluralities
ordain and establish Jim Crow and slavery laws
and so on
.. so it matters not much whether democracy is endangered by bailouts.
What does happen is that world peace and human liberty and prosperity are massively endangered by the downline effects of inflationary funding on a huge scale, centralized financing not responsive to market pressures and incentives.
The nasty effect could occur in a growing country which sets up a HitlerStalinmao in a time of economic collapse a generation hence (happened before), even as the US remains more or less a democracy, perhaps even more so, as we grant voting rights to aliens to lure them here to pay for the vast government outlays promised to the elderly and unwisely indebted.
Democracy may only be a small at-risk thing (though ancient Rome may provide an example of centralization as a risk); but catastrophe for lives and liberty elsehwere and here, a big one and because of the economic effects of artificial money and related moral hazard and complacency created to please political constituencies, including the bulk of the populace and aided by card-carrying friends of Rand who act somewhat differently when in power.
Democracy does not equal liberty, or prosperity, or a guarantee of social virtue. It’s just one of many useful safeguards for the collective human spirit.
Comment by Thoreau —
November 25, 2008 @ 6:19 pm
That’s a big part of it, Eric.
Comment by Eric the .5b —
November 25, 2008 @ 6:20 pm
What’s the rest, Thoreau?
Comment by abb1 —
November 25, 2008 @ 6:29 pm
Eric, it’s 7 million people – and still they break it into 26 cantons that are much more autonomous than any (peaceful) administrative division anywhere, except maybe Hong Kong within China. And the cantons are divided into much smaller ‘communes’ with a few thousand people population and these communes are at least as autonomous as the states in the US, if not more so. Most of the taxes, more than 80% probably, are collected and spent on the canton/commune level; every project, like building a shopping center, or apartment block, or a tram line, is approved by a commune referendum, not decided by corrupt politicians.
This is a distinct philosophy of government and I don’t see how it can be dismissed as irrelevant, no matter what the size or history.
Perhaps it was stumbled upon by chance, but then perhaps it needs to be copied and accepted everywhere.
Comment by Thoreau —
November 25, 2008 @ 6:35 pm
Eric,
Randians are a big part of it. Also, the ones who even go beyond equating anything other than nightwatchman with socialism, and also argue that any sort of social spending is no different from [insert favor for crony here] because it’s all just the state taking money and spending it. Yes, there are some similarities, but there are also differences of degree, and those differences of degree can spell the difference between a functional society and a corruption-ridden one.
Comment by Eric the .5b —
November 25, 2008 @ 7:21 pm
“Switzerland is awesome” may be true, but how is it relevant to this?
Comment by Eric the .5b —
November 25, 2008 @ 7:22 pm
Thoreau: I gotcha.
Comment by bartkid —
November 25, 2008 @ 7:40 pm
>I’d like to find that person and punch him in the face.
Terence (ancient Roman playwright) would want to get in line in front of you:
“How unfair the fate which ordains that those who have the least should be always adding to the treasury of the wealthy.â€
Comment by dhex —
November 25, 2008 @ 7:49 pm
The University of Chicago has remade “the modern discipline of economics†in the image of libertarian ideology
would you get out of my dreams and into my car already?
Comment by Neel Krishnaswami —
November 25, 2008 @ 9:17 pm
No, this is not what happened. By suggesting that it’s the unregulated nature of the market that was the problem, you are letting your ideology get in the way of reality. The real story is very complex, and has a lot of moving parts.
It starts with the fact that real estate markets are illiquid and inefficient — if you look at (say) the Case-Shiller indexes, you’ll notice that there are a lot of smooth trendlines in real estate prices. So it takes a long time for new information to be properly accounted for in house prices, which means that prices tend to overshoot (bubble) and undershoot (bust).
Now, observe that in a bust, home values fall, and that they often fall below the outstanding loan amount on a house. Whenever this happens, default rates shoot way up. Next, note that banks tend to lose a lot of money on every default — they have to sell the house at auction, which means that it’s sold at a large discount. Finally, note that banks tend to lend to homeowners in particular geographic regions, which means that if a bust hits they are subject to a wave of defaults all hitting all at once.
When a bank loses a lot of money all at once, it can go under, and this is obviously a bad thing. This is one of the things that Fannie and Freddie were invented to help alleviate. The idea was that loans could be pooled. You buy mortgages from banks all over the country, and then sell shares of the loan portfolios back to the banks. This way, banks would be able to reduce their exposure to geographically-concentrated risk, which reduced the chance any individual bank would go under. This market got a lot larger in the 1980s, when investment banks (in addition to Fannie and Freddie) got into the act. Because their CMOs were not guaranteed by the government, they divided them into tranches, in which you pay more for the right to be the first person to get repaid in case of default, in order to allow hedging that risk.
Next, in the nineties something unusual happened — all of the major real estate markets in the US went into a boom at the same time. This is bad, because it means that when they were likely to all burst at the same time. Call this problem #1.
Then, also in the nineties, problem #2 started. Unscrupulous banks realized that the fact that they were sharing risk via mortgage securitization meant that they could cheat. They began straight-up lying about how much houses were worth, by using tame appraisers to report bogus numbers to the rating agencies. This meant that all of the models and pricing strategies for every mortgage-based security was garbage, because the models were getting fed garbage numbers. Nobody realized this, because of problem #1 — the real-estate bubble covered for the risk because absolute default rates stayed very low.
This also led to problem #3. Because of the massive growth in derivatives markets, financial regulators around the world decided to try and make their regulations more uniform (i.e., the Basel II process) in order to prevent banks and other financial institutions from using derivatives to engage in regulatory arbitrage. In particular, they made the decision to treat all assets uniformly — the important thing was how safe the ratings agencies rated an asset, not what the type of asset it was. This meant that banks could legally use the senior tranches of commercial mortgage-based securities to meet their reserve requirements, which they did.
This is the fundamental cause of the crisis. When the bust happened, it not only increased default rates, it also revealed that the prices and valuations people thought were true were actually false, which then meant that bank reserves were lower than people thought they were, which meant that banks were less able to sustain losses than they thought they could, which meant that they were less willing to lend money to one another, which drove up the price of borrowing far above the levels anyone expected, and so on….
If anyone tells you that the problem lay in the complexity of the derivatives market, they’re indulging in unthinking math phobia. It’s not stochastic calculus that’s at fault — the problem was fraud, pure and simple, on the part of many lending institutions. (All of which, mind, were very heavily regulated.)
Comment by von Laue —
November 25, 2008 @ 9:59 pm
Neel, I dig what you’re saying, but this fails to explain a RE bubble in Spain, and Ireland, and Australia, and the UK, and pretty ridiculous prices in France from what I saw…kinda weird that that all happened at the same time.
Let’s not forget the whole “the Chinese OWN us now” bullshit meme, which sounds like “the saudis OWN us” or “the japanese OWN us” anymore. fradulent appraisal (a very real thing) hardly explains all that.
Comment by albatross —
November 25, 2008 @ 10:52 pm
I keep thinking a lot of the story of this crisis is about the way everyone was assessing risk. The bursting of the US real estate bubble made it clear that the commonly-used risk assessment mechanisms were massively wrong. That lesson was received by a lot more people than those invested in the US housing bubble’s inflated mortgage backed securities.
Comment by abb1 —
November 26, 2008 @ 3:35 am
@33, um, it seems very relevant. It’s an empirical proof that the word ‘democracy’ doesn’t really describe much; there is a bunch of other parameters that determine the outcome at least as much as the value of the ‘democracy’ parameter.
Comment by Barbar —
November 26, 2008 @ 4:46 am
I spent some time talking with a Swiss political scientist once. He said the Swiss political system was pretty unique, but if you wanted a decent analogy you could imagine the American political system.
Comment by abb1 —
November 26, 2008 @ 6:29 am
American political system 200 years ago, maybe.
I think there is huge difference between a democracy exercised by 300 million people all together in the scope of the whole country, with no place left to go for any individual who happened to strongly disagree with the opinion of a majority (or, much worse, a super-majority) – and a democracy exercised by a few thousand people in a local ‘commune’ that you can easily leave and move to a neighboring town where people with views more similar to yours live.
Again, it’s not a subtle difference, it’s a huge, critically important difference.
Comment by ajay —
November 26, 2008 @ 6:54 am
Neel, I dig what you’re saying, but this fails to explain a RE bubble in Spain, and Ireland, and Australia, and the UK, and pretty ridiculous prices in France from what I saw…kinda weird that that all happened at the same time
It’s all connected – interest rates were low around the world, so there was lots of money looking for a home, and after the dotcom bubble no one wanted to invest in equities – but real estate always goes up, right?
Comment by von Laue —
November 26, 2008 @ 8:37 am
ajay, exactly. a worldwide RE bubble certainly makes it ridiculous to think that the CRA is the root of all this. Crazy leverage all over the world is. I don’t know why I never see anyone bitching about, say, the years of ZIRP at Bank of Japan and credit expansion in Europe over the last decade.
Oh, wait, I do know. We’re americans, and if there’s one thing every political faction can agree on, it’s that everything everywhere is/was under our control somehow.
Comment by joe from Lowell —
November 26, 2008 @ 10:25 am
Picador, I’m intrigued that the guy running the Fed in your alternate dimension had an Ayn Rand fetish, too.
This is a joke, right? You aren’t actually unaware of Greenspan’s long history as a Rand disciple, right?
Comment by Neel Krishnaswami —
November 26, 2008 @ 1:10 pm
Actually, they did a great job. The regulators and rating agencies were really on the ball — Basel II was the result of smart people anticipating problems and applying the best available science to head them off in a fair and efficient way. I mean, of course there were some political sausages in the mix, but even those were a lot fewer than normal. I have no essential complaints about that particular regulatory process, and I’m saying this as a libertarian prone to regulatory skepticism, and with the full benefit of hindsight.
The trouble is simply that the risk models got fed bad data. Garbage in, garbage out.
I should explain what these models are, so you can understand how simple and un-complicated they are. The way things worked is that before a loan is made, the bank hires an appraiser to estimate the market value of the property, and they divide the requested loan by the appraisal to calculate a loan-to-value ratio. Then they look up a table of historical default rates, based on the borrower’s income and the loan-to-value ratio, and use this to decide whether the loan is risky or not. That’s it — this hardly deserves a term as fancy as “model”, it’s so simple.
When mortgage companies bought loans, they also bought this information, so that they could build their own risk estimates. These were also usually very simple — some really basic probability theory can tell you how much less risky the shares of a loan portfolio are, over individual loans. That’s how they were supposed to make money.
Banks were simply straight-up lying about the value of houses. How they lied is the only clever part of this whole story. Note that banks had the responsibility of hiring an appraiser. If a loan officer wanted to make a bad loan, what he or she would do is call the appraiser, and ask “Is this house worth $200,000?” (or whatever bogus number they wanted to hear). Then, either the appraiser said “yes”, or next time they would hire a different appraiser. So appraisers, who were supposed to supply an honest outside opinion, didn’t, because they wanted repeat business.
Furthermore, this meant that auditors could never find any direct evidence of fraud, because all the procedures were followed and the appraiser really did supply the reported number, no matter how bogus it was. And so the mortgage company that bought the loan would get an inflated number for the market value, and so they thought the loan-to-value ratios were lower than they really were, which meant they looked in the wrong row of the table. And there’s the problem.
Come now — it’s not ridiculous at all, if you’re a racist trying to find some reason why it’s black people who are fault for driving down your property values.
Comment by GinSlinger —
November 26, 2008 @ 1:11 pm
c’mon joe, you can do better than that.
Have you read Greenspan’s articles in the Rand newsletters? If you have, you’re being dishonest in not drawing a distinction between Greenspan the Randian and Greenspan the Fed Chairman.
The guy’s most famous in the Randroid circles for his defense of the gold standard, and most famous as a Fed Chairman for doing the exact opposite.
Comment by Eric the .5b —
November 26, 2008 @ 2:55 pm
I am aware. If a little emphasis helps you out, here:
Comment by joe from Lowell —
November 26, 2008 @ 6:39 pm
Whoops, I misread you, Eric. My bad.
Ginslinger,
Have you read Greenspan’s articles in the Rand newsletters? I read the letter he wrote, I think to National Review, defending her honor.
As Fed Chairman from 1987 – 2005, he did precisely nothing regarding the gold standard. He did argue pretty vociferously against regulation, owing to his late-in-life realization that his philosophy of markets was wrong.
Comment by ajay —
November 27, 2008 @ 10:34 am
Hmm. Surely the gold standard wasn’t something he could do much about? Wouldn’t that be a decision for the Treasury Secretary or someone?
Anyway, there’s more to being a Randian than just wanting a gold standard, presumably.
Comment by albatross —
November 30, 2008 @ 10:59 am
Neel:
I’ve heard of this and other ways of gaming the inputs to the model. It’s hard to imagine that sophisticated investors didn’t know such fraud was happening (I knew about it, and wasn’t investing millions into that market). But I think the persistent rise in house prices made that fraud invisible in terms of defaults.
And that’s a more fundamental problem, right? I’m pretty sure those tables you’re talking about were derived from historical data, and the historical data came from times when house prices were going up or at worst flat (and when they were flat, the banks that sold the mortgages were not engaging in nearly as much fraud, apparently). So the default rates were conditioned on rising prices, and when the rising prices stopped, the default rates were wrong.
And finally, the model for defaults you’re talking about was for individual defaults. What we’re seeing here is a change in the environment that changes the default probability for everyone all at once. That’s not just falling prices, it’s also a slumping economy, a slower market (so you can’t manage to sell that house off before the bank forecloses), and tighter requirements for refinancing.
Do you know if the models used for other defaults (say, on bonds) are also built on individual-default-risk only, rather than having some term in them for widespread defaults? My sense is that most everyone ignores that risk, and that this is part of why now nobody is sure how to evaluate risk of their other investments (particularly, risk of default of financial institutions, whose risks often include lots of exposure to *other* financial institutions’ default risk).