"Securitization — and the business of finance — can resume where it left off a year or two ago." Agree or disagree?
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The Market Mystique
By PAUL KRUGMAN
Published: March 26, 2009
On Monday, Lawrence Summers, the head of the National Economic Council, responded to criticisms of the Obama administration’s plan to subsidize private purchases of toxic assets. “I don’t know of any economist,” he declared, “who doesn’t believe that better functioning capital markets in which assets can be traded are a good idea.”
Leave aside for a moment the question of whether a market in which buyers have to be bribed to participate can really be described as “better functioning.” Even so, Mr. Summers needs to get out more. Quite a few economists have reconsidered their favorable opinion of capital markets and asset trading in the light of the current crisis.
But it has become increasingly clear over the past few days that top officials in the Obama administration are still in the grip of the market mystique. They still believe in the magic of the financial marketplace and in the prowess of the wizards who perform that magic.
The market mystique didn’t always rule financial policy. America emerged from the Great Depression with a tightly regulated banking system, which made finance a staid, even boring business. Banks attracted depositors by providing convenient branch locations and maybe a free toaster or two; they used the money thus attracted to make loans, and that was that.
And the financial system wasn’t just boring. It was also, by today’s standards, small. Even during the “go-go years,” the bull market of the 1960s, finance and insurance together accounted for less than 4 percent of G.D.P. The relative unimportance of finance was reflected in the list of stocks making up the Dow Jones Industrial Average, which until 1982 contained not a single financial company.
It all sounds primitive by today’s standards. Yet that boring, primitive financial system serviced an economy that doubled living standards over the course of a generation.
After 1980, of course, a very different financial system emerged. In the deregulation-minded Reagan era, old-fashioned banking was increasingly replaced by wheeling and dealing on a grand scale. The new system was much bigger than the old regime: On the eve of the current crisis, finance and insurance accounted for 8 percent of G.D.P., more than twice their share in the 1960s. By early last year, the Dow contained five financial companies — giants like A.I.G., Citigroup and Bank of America.
And finance became anything but boring. It attracted many of our sharpest minds and made a select few immensely rich.
Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.
But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.
Sooner or later, things were bound to go wrong, and eventually they did. Bear Stearns failed; Lehman failed; but most of all, securitization failed.
Which brings us back to the Obama administration’s approach to the financial crisis.
Much discussion of the toxic-asset plan has focused on the details and the arithmetic, and rightly so. Beyond that, however, what’s striking is the vision expressed both in the content of the financial plan and in statements by administration officials. In essence, the administration seems to believe that once investors calm down, securitization — and the business of finance — can resume where it left off a year or two ago.
To be fair, officials are calling for more regulation. Indeed, on Thursday Tim Geithner, the Treasury secretary, laid out plans for enhanced regulation that would have been considered radical not long ago.
But the underlying vision remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.
As you can guess, I don’t share that vision. I don’t think this is just a financial panic; I believe that it represents the failure of a whole model of banking, of an overgrown financial sector that did more harm than good. I don’t think the Obama administration can bring securitization back to life, and I don’t believe it should try.
With the proper regulation, securitization won't be like it was a year or two ago. It was in hyper overdrive on steroids, and like a man's heart beating faster and faster out of control. It was bound to burst just like the housing bubble that was part of it all.
And it's not so much that people were frauds, they were in a feeding frenzy.
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That the rating agencies (S&P, Moody's) at least do a little due diligence before they slap a AAA rating on every single freaking bundle of worthless paper. I'm sure the fact that the ratings agencies are compensated by the paper issuers had nothing to do with all those AAA ratings they gave that junk. Riiiiight....
If securitization is here to stay, put in place a legitimate, arms length rating system/agency so the buyers have a fighting chance at understanding their risk. I get the "buyer beware" principle of our society, but investors are only now realizing that the previously reputable agencies did next to no due diligence on the structured securities. Investors were duped and the issuers were emboldened to go after riskier and riskier home loans, knowing S&P and Moody's were rubber stamping every piece of worthless paper put in front of them (all the while being compensated by the paper issuers). In hindsight, it's a recipe for collapse.
Without a 3rd party rating system, I think it's going to be a long while before buyers embrace structured securities, especially in US residential mortgages. They were the first to explode. Next up, US commercial real estate, credit card and auto loan securities. If the economy doesn't turn around soon (and I have my doubts about this), watch out for these cards to fall.
Not the Obama, bigger government and more government control, type, but rather the complete government control, limited private industry type that would like to see a massive welfare state responsible for the substistence of a majority of the population, right?
Whatever you think of his politics, he's got a point.
people allowed him to grab that much control. Of course, I was looking at those events in hindsight, which made them ever so clear.
It's interesting to watch seemingly intelligent people get duped. It really is.
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You really think he was a good source for promoting peace? I dont know what is more annoying, Obama spending time daily in front of the cameras, or any of Krugman's crap that comes out every week. If the man is so fucking smart, maybe he should quit hiding at Princeton and the NY Times, and start putting all that "knowledge" to good use in the WH. OF course he doesnt because its always much easier to armchair quarterback like he does with every opinion aritcle rather than run the risk that some of your ideas turn out to be crap. Krugman is an egotistical jackass who just cant get enough of reading his own words in print.
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I got it at the bottom of a box of Lucky Charms. Big deal. Call me when Krugman can play football at a high level.
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...the banks are holding Washington hostage in a high stakes game of "chicken"...Wall Street will never self-regulate...Bams has his hands full...the cigar-filled back room is where I'd like to sit...
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...IIIIIII'm sorry...I can't argue anymore unless you pay me...