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Examining the big lie: How the facts of the economic crisis stack up
Barry Ritholtz
Washington Post, November 19

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It’s fair to say that our discussion about the big lie touched a nerve.

The big lie of the financial crisis, of course, is that troubling technique used to try to change the narrative history and shift blame from the bad ideas and terrible policies that created it.

Based on the scores of comments, people are clearly interested in understanding the causes of the economic disaster.

I want to move beyond what I call “the squishy narrative” — an imprecise, sloppy way to think about the world — toward a more rigorous form of analysis. Unlike other disciplines, economics looks at actual consequences in terms of real dollars. So let’s follow the money and see what the data reveal about the causes of the collapse.

Rather than attend a college-level seminar on the complex philosophy of causation, we’ll keep it simple. To assess how blameworthy any factor is regarding the cause of a subsequent event, consider whether that element was 1) proximate 2) statistically valid 3) necessary and sufficient.

Consider the causes cited by those who’ve taken up the big lie. Take for example New York Mayor Michael Bloomberg’s statement that it was Congress that forced banks to make ill-advised loans to people who could not afford them and defaulted in large numbers. He and others claim that caused the crisis. Others have suggested these were to blame: the home mortgage interest deduction, the Community Reinvestment Act of 1977, the 1994 Housing and Urban Development memo, Fannie Mae and Freddie Mac, Rep. Barney Frank (D-Mass.) and homeownership targets set by both the Clinton and Bush administrations.

When an economy booms or busts, money gets misspent, assets rise in prices, fortunes are made. Out of all that comes a set of easy-to-discern facts.

Here are key things we know based on data. Together, they present a series of tough hurdles for the big lie proponents.

•The boom and bust was global. Proponents of the Big Lie ignore the worldwide nature of the housing boom and bust.

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The housing boom and bust was global — Source: McKinsey Quarterly
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A McKinsey Global Institute report noted “from 2000 through 2007, a remarkable run-up in global home prices occurred.” It is highly unlikely that a simultaneous boom and bust everywhere else in the world was caused by one set of factors (ultra-low rates, securitized AAA-rated subprime, derivatives) but had a different set of causes in the United States. Indeed, this might be the biggest obstacle to pushing the false narrative. How did U.S. regulations against redlining in inner cities also cause a boom in Spain, Ireland and Australia? How can we explain the boom occurring in countries that do not have a tax deduction for mortgage interest or government-sponsored enterprises? And why, after nearly a century of mortgage interest deduction in the United States, did it suddenly cause a crisis?

These questions show why proximity and statistical validity are so important. Let’s get more specific.The Community Reinvestment Act of 1977 is a favorite boogeyman for some, despite the numbers that so easily disprove it as a cause.It is a statistical invalid argument, as the data show.

For example, if the CRA was to blame, the housing boom would have been in CRA regions; it would have made places such as Harlem and South Philly and Compton and inner Washington the primary locales of the run up and collapse. Further, the default rates in these areas should have been worse than other regions.

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CRA were less likely to default than Subprime Mortgages — Source: University of North Carolina at Chapel Hill
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What occurred was the exact opposite: The suburbs boomed and busted and went into foreclosure in much greater numbers than inner cities. The tiny suburbs and exurbs of South Florida and California and Las Vegas and Arizona were the big boomtowns, not the low-income regions. The redlined areas the CRA address missed much of the boom; places that busted had nothing to do with the CRA.

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Suburbs and Exurbs were where the boom & bust occurred — and not the CRA regions — Source: Washington Post
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The market share of financial institutions that were subject to the CRA has steadily declined since the legislation was passed in 1977. As noted by Abromowitz & Min, CRA-regulated institutions, primarily banks and thrifts, accounted for only 28 percent of all mortgages originated in 2006.

•Nonbank mortgage underwriting exploded from 2001 to 2007, along with the private label securitization market, which eclipsed Fannie and Freddie during the boom.

Check the mortgage origination data: The vast majority of subprime mortgages — the loans at the heart of the global crisis — were underwritten by unregulated private firms. These were lenders who sold the bulk of their mortgages to Wall Street, not to Fannie or Freddie. Indeed, these firms had no deposits, so they were not under the jurisdiction of the Federal Deposit Insurance Corp or the Office of Thrift Supervision. The relative market share of Fannie Mae and Freddie Mac dropped from a high of 57 percent of all new mortgage originations in 2003, down to 37 percent as the bubble was developing in 2005-06.

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Nonbank mortgage underwriting exploded from 2001 to 2007, along with the private label securitization market, which eclipsed Fannie and Freddie during the boom – Source: University of North Carolina at Chapel Hill
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•Private lenders not subject to congressional regulations collapsed lending standards. Taking up that extra share were nonbanks selling mortgages elsewhere, not to the GSEs. Conforming mortgages had rules that were less profitable than the newfangled loans. Private securitizers — competitors of Fannie and Freddie — grew from 10 percent of the market in 2002 to nearly 40 percent in 2006. As a percentage of all mortgage-backed securities, private securitization grew from 23 percent in 2003 to 56 percent in 2006

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Subprime Lenders were (Primarily) Private

Only one of the top 25 subprime lenders in 2006 was directly subject to the housing laws overseen by either Fannie Mae, Freddie Mac or the Community Reinvestment Act — Source: McClatchy
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These firms had business models that could be called “Lend-in-order-to-sell-to-Wall-Street-securitizers.” They offered all manner of nontraditional mortgages — the 2/28 adjustable rate mortgages, piggy-back loans, negative amortization loans. These defaulted in huge numbers, far more than the regulated mortgage writers did.

Consider a study by McClatchy: It found that more than 84 percent of the subprime mortgages in 2006 were issued by private lending. These private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year. And McClatchy found that out of the top 25 subprime lenders in 2006, only one was subject to the usual mortgage laws and regulations.

A 2008 analysis found that the nonbank underwriters made more than 12 million subprime mortgages with a value of nearly $2 trillion. The lenders who made these were exempt from federal regulations.

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Lenders made 12 million subprime mortgages with a value of nearly $2 trillion. Mortgage Companies and Thrifts NOT affiliated with CRA made 75% of Subprime Loans from 2004-07, Source: Orange County Register
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A study by the Federal Reserve shows that more than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions. The study found that the government-sponsored enterprises were concerned with the loss of market share to these private lenders — Fannie and Freddie were chasing profits, not trying to meet low-income lending goals.

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Fannie and Freddie risky loan purchases was dwarfed by Private Label Securitization Source: University of North Carolina at Chapel Hill
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Beyond the overwhelming data that private lenders made the bulk of the subprime loans to low-income borrowers, we still have the proximate cause issue. If we cannot blame housing policies from the 1930s or mortgage tax deductibility from even before that, then what else can we blame? Mass consumerism? Incessant advertising? The post-World War II suburban automobile culture? MTV’s “Cribs”? Just how attenuated must a factor be before fair-minded people are willing to eliminate it as a prime cause?

I recognize all of the above as merely background noise, the wallpaper of our culture. To blame the housing collapse that began in 2006, a recession dated to December 2007 and a market collapse in 2008-09 on policies of the early 20th century is to blame everything — and nothing.

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Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture.

Changing the Rules in the Middle of the Game
By John Mauldin
November 25, 2011

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Changing the Rules
When Even Germany Fails
European Inverted Yield Curves
Time to Review the Bang!Moment
The Risk of Contagion in the US
Time to Start Watching China
New York, China, and Some Links

Angela Merkel is leading the call for a rule change, a rewiring of the basic treaty that binds the EU. But is it both too much and too late? The market action suggests that time is indeed running out, and so we’ll look at the likely consequences. Then I glance over the other way and take notice of news out of China that may be of import. Plus a few links for your weekend listening “pleasure.” There is lots to cover, so let’s get started.

Changing the Rules

I have been writing for a very long time about the changes needed to the EU treaty if Europe is to survive. Specifically, last week I noted that Angela Merkel has made it clear that the independence of the ECB must not be compromised. This week Sarkozy and the new prime minister of Italy, Mario Monti, agreed to stop their public calls for such changes (at least until their own crises get even worse, would be my guess). And Merkel has called for a new, stronger union with strict control of budgets as the price for further German aid for those countries in crisis. In seeming response:

“The European Commission on November 23 proposed a new package including budget previews at EU level, the establishment of independent fiscal councils and growth forecasts, closer surveillance of bailout recipients and a consultation paper on Eurobonds. There is also a growing consensus among EU policy makers on the need for the adoption of fiscal rules in national legislation. However, it is far from clear whether EU countries would accept the implicit loss of sovereignty this would involve and agree to treaty changes enshrining legally enforceable fiscal oversight at EU level. The German Chancellor, Angela Merkel, is willing to support a change in Germany’s own constitution if the EU Treaty change to that effect is agreed first.” (www.roubini.com)

But this means a major treaty change that must be approved by all member countries. Note that Merkel wants the treaty change first, or at least the language, before she takes it to German voters, which will certainly be required, since what she is suggesting is not allowed by the present German constitution. Without the changes stated clearly and explicitly in advance, it is unlikely, as I read the polls, that German voters will go along. Merkel has made it clear that any proposed changes will be limited to fiscal issues and central control and not touch on the ECB’s independence. She is adamant against eurozone bonds and putting the German balance sheet at risk (see more below).

But will the rest of Europe go along with what would be a major alterations of their own individual sovereignty and their ability to adjust their own budgets, no matter what? And agree to all this in time to deal with the current crisis? Such changes will be controversial, to say the least. And they would require, if I understand, the yes votes of all 27 European Union members, or at a minimum the 17 eurozone members.

That is problematical. Will even German voters give up their independence and listen to an EU commission tell them what they can and cannot do with their own budget? A budget that is in theory controlled by the rest of Europe? The answer depends on whom you listen to last, as the answers range all over the board.

When Even Germany Fails

Let’s get back to the German balance sheet. This week the markets were greeted with a failed German bond offering. The German central bank had to step in and buy German bunds, at a recent-series-high rate. And while the “trade” has been to buy German bunds as a hedge, Germany is not precisely a model of balance and austerity, with high (above 4%) deficits and a rising debt-to-GDP ratio. And the market senses the contradictions here. When even German bond auctions fail, whither the rest of Europe?

As a quick aside, notice that German yields are not higher than those of UK debt at some points. The market is clearly signaling that the lack of a national central bank with a printing press is an issue. Go figure. But that is a story for another letter at another time.

Let’s look at some recent headlines. Greek 2-year bonds are now at 116%. You read that right. “Bond yields on short-term Italian debt rose above 8 per cent on Friday as Rome was forced to pay euro-era-high interest rates in what analysts called an ‘awful’ auction. A peak of 8.13 per cent was reached on three-year bonds, according to Reuters data, as Italian debt traded deeper into territory associated with bail-outs of Greece, Portugal and Ireland in the past 18 months.

“Italy raised its targeted €10bn in an auction of two-year bonds and six-month bills but at sharply higher yields. ‘Rates have skyrocketed. It’s simply not sustainable in the long run,’ said Marc Ostwald, strategist at Monument Securities in London.

“Investors demanded a yield of 7.81 per cent for the two-year bond, up from 4.63 per cent last month. The six-month bills saw yields of 6.50 per cent, up from 3.54 per cent. That was significantly higher than Greece paid for six-month money earlier this month when it issued bills at 4.89 per cent.” (Reuters)

Spanish bond yields are slightly lower but not by much, with both countries paying more for short-term debt than Greece.

And no one is really talking about Belgium, which I have been pointing to for some time. Belgium debt yield on its ten-year bonds went to 5.85%. Notice the recent trend, in the chart below. It looks like Greece in the not-very-distant past. (Chart courtesy of Roubini.com and Reuters data)

European Inverted Yield Curves

Let’s rewind the tape a little bit. Both the Spanish and Italian bond markets are close to or already in an “inverted” state. That is when lower-term bonds yield higher than longer-term bonds, which is not a natural occurrence. Typically, when that happens, the markets are sending a signal of something. (Charts below courtesy of my long-suffering Endgame co-author, Jonathan Tepper of Variant Perception, who lets me call him up late for data like this.)

Note that Greece (especially) and Portugal inverted when they began to enter a crisis. And shortly thereafter they went into freefall. Why did it happen so suddenly?

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Google Street View stop motion animation short made as a personal project by director Tom Jenkins.

Story: A lonely desk toy longs for escape from the dark confines of the office, so he takes a cross country road trip to the Pacific Coast in the only way he can – using a toy car and Google Maps Street View.

Address Is Approximate from The Theory on Vimeo.

Music by the wonderfull Cinematic Orchestra (cinematicorchestra.com) and the track is Arrival of the Birds – please buy the fantastic album: itunes.apple.com/gb/album/the-crimson-wing-mystery-flamingos/id297787201

All screen imagery was animated – there are no screen replacements.

Produced, animated, filmed, lit, edited & graded by Tom Jenkins (theoryfilms.co.uk / facebook.com/theoryfilms – !NEW MAKING OF PICS ON FB PAGE! / @thetheoryUK / twitter.com/#!/thetheoryUK).

Shot using Canon 5d MkII, Dragonframe Stop Motion software and customised slider.

The Gallardo LP 550-2 Spyder, as its name implies, is a convertible that features a 550HP V10 that, unlike the standard Gallardo, directs all its power to the rear wheels. Top speed is 199mph with 0-60mph runs of 4 seconds flat.

Source: Lamborghini LP 550-2 Spyder Unveiled In L.A.
Classic Driver, November 19, 2011

Thanksgiving, Ben Bernanke, WSJ Story (11/23/2011)
David R. Kotok
November 25, 2011

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Wall Street Journal readers saw the front-page story entitled “Investors Bullish on Fed Tips,” by Susan Pulliam. The opening discussion was alarming.

The story discusses private conversations that took place between Fed Chairman Ben Bernanke and Nancy Lazar, an economist with International Strategy & Investment Group, Inc. The story reports that they met in Bernanke’s office on August 15th. The story goes on to suggest that Lazar then hastily alerted her clients that a modern version of “Operation Twist” was coming.

WSJ says Lazar declined to comment. The Fed’s calendar entry confirms the meeting. So why is this meeting and report so alarming? Other meetings with Bernanke and NY Fed President Dudley were also reported. What’s the big deal?

It is standard procedure for Fed officials to meet with market participants to gain “color” from the market. Such inquiries by the Fed are a way in which they are supposed to gain insight. Some of those meetings are conducted with a small group of participants.

I have been involved in such meetings over the years. From my experience, those meetings are focused on the guests. The gatherings are small and without press, so all in attendance can speak freely. The Fed official leading the meeting asks numerous questions. The Fed official usually has staff present, and they occasionally take notes. Guests offer diverse views. Sometimes the debates become fierce. The Fed official listens. Sometimes she/he even stirs the debate with questions. Often, the official summarizes and may add perspective.

In all of my experience over the last 30 years never was I or another member of the group “tipped off” by a Fed official with a prediction of what the Fed was going to do. Federal law and the Fed code of ethics prohibit such behavior.

I did not read the Lazar comment, so I have no firsthand knowledge of what she said to her clients with her hastily drafted advice. I have read the reports of others who participated in such meetings. In some cases my colleagues and I have publically noted conversations with Fed officials. To my best recollection, we have never published our views on future Fed policy with a representation that it was sourced to a Fed official and originated in a private conversation.

These private conversations and this story have created a dilemma for the Fed.

On one hand, Fed officials want as much information as they can obtain from market participants. The best information comes from those who are in the markets on a daily basis. These are the folks who follow the markets most closely. They are executing transactions. They are part of the process that is determining market-based pricing of financial instruments of all types. The Fed needs to learn all it can from them.

On the other hand, a Fed official should never place him- or herself in a position to purposefully give away possible Fed policy. To give the policy initiative away to anyone is to put money in someone’s pocket at the expense of everyone who was not in the meeting. Such behavior weakens Fed credibility and eventually harms the entire financial system. Without integrity and honesty, a central bank has nothing.

How should Fed officials walk this fine line between obtaining information and conveying policy?

The story that is reported in the Wall Street Journal is distressing on the face of it. Of course, only Nancy Lazar and Ben Bernanke know what information was exchanged between them. The rest of us have to surmise. Perhaps Bernanke inquired as to how markets would take certain transactions, without disclosing what the policy might be. He may have asked questions. Nancy Lazar may have determined, on her own and solely from the nature of the questions that the Fed was seriously considering such a policy.

It is hard to imagine that Ben Bernanke actually leaned over to Nancy Lazar and said “Shh, don’t tell anybody but we are going to do an Operation Twist.” We doubt it. But only those in the room know the truth.

What about Lazar? How did she reach her conclusions? From what we can see, she didn’t break any law. There are no insider trading rules on interpretation of Fed policy or forecasts of same.

I look at the WSJ article and think, “How would those meetings have been reported? How would the story have read if every detail of meetings of this type were made public? In those meetings, anyone could walk out, call their clients, and honestly say, “Here is what I think is going on.” That would be an honest conveyance of information. Furthermore, the public could see if anyone in the Fed was playing favorites. Bernanke would have to explain any reports in his public press conferences. In addition, the Fed official could determine that certain guests had “stepped over the line” and misadvised clients or improperly conveyed discussions.

The Fed needs to decide how it is going to walk this fine line between a private inquiry into obtaining market information and an inappropriate information transfer.

One thing is clear: one-on-one calendar-listed meetings with the Chairman of the Federal Reserve or with a member of the Federal Open Market Committee are much riskier than meetings in which at least several participants are in the same place. The exclusivity of the single private interview is then eliminated. So is the risk of misinterpretation.

Some Federal Reserve officials are presently working on the Fed’s communication system. I am certain that they are examining new forms of transparency. They must now consider this WSJ story and its implications. We will learn from the minutes of the FOMC whether there is any discussion of this Wall Street Journal front-page story.

For us, this was not a good story to read at the beginning of the Thanksgiving holiday. It came on the heels of a dire bond auction in Germany, widening credit spreads in Europe, and a very heated discussion of policy options for the European Central Bank. It came along with the ongoing debate over QE3 and Federal Reserve policy for the US economy. It came in the wake of the announcement that the Federal Reserve is advancing a new form of intense stress tests of large US banks. And it came on the heels of the failure of the super-committee.

This was an inauspicious start to the Thanksgiving holiday. Add to it five extra airport travel hours and the need grew for a fine red wine to accompany our turkey. I hope, dear reader, that your Thursday meal and gathering were pleasant. Two healthy grandchildren and family warmth by a fireplace were the best enhancements of mine.

Happy holiday.

David R. Kotok, Chairman and Chief Investment Officer

Another look at who is buying what gadget. . .

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infographic after the jump:

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Hat tip Real Clear Politics

Consider New Zealand:

To highlight how late the S&P call was on Belgium and the catch up to the markets they are doing, even as they were a step ahead of Moody’s and Fitch, Belgium with now a AA rating has the same credit rating as New Zealand. However, Belgium 5 yr CDS is trading 410 bps and New Zealand is only at 107 bps. Also, Belgium’s 10 yr yield is at 5.86% vs 3.96% in New Zealand.

Reading for your mass consumerism pleasure:

• Why We (USA) Spend, Why They (Europe) Save (NYT)
• Economic News We’re Thankful For This Thanksgiving (Daily Beast)
• Black Friday
…..-Friday’s Deals May Not Be the Best (NYT)
…..-The Limits of Black Friday and Cyber Monday (WSJ)
…..-Black Friday Sales ’About Same’ as 2010 (Bloomberg)
• The Fraying of China’s Gilded Age (Diplomat)
• How Germany Can Save the Euro (Vox EU)
• Patently American How the U.S. can sharpen its innovative edge (City-Journal)
• The Mortgage of the Future (Businessweek)
• Confidence Game: The limited vision of the news gurus (Columbia Journalism Review)
• Hidden iPhone Tricks: Secret Keyboard and Panoramic Photos (Time)
• The Sketchbook of Susan Kare, the designer of the original icons for the Macintosh (NeuroTribes)

What are you reading?

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Debt Slave

Hat tip Dont Tread on Me

Via Mint, we see this City guide to Black Friday Spending:

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infographic after the jump:

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