Arnold Kling is a libertarian economist who once worked for Freddie Mac. This article discusses a blog and an article he wrote about the causes of the crisis. Both (unintentionally) illustrate key theoclassical economic positions critical to understanding the origins of the crisis. Kling’s blog was in response to a January 29, 2013 post by Thomas J. Sugrue. Sugrue provided data demonstrating that blacks and Latino homeowners suffered far greater wealth losses in the crisis than did whites. This upset Kling, who responded:
The only positive aspect of the public contest to pick a successor for Ben Bernanke that the White House has inexplicably sparked is that economists are acknowledging that the next head of the Fed must act to create (not “restore”) effective regulation by the agency. It is long past time to have a serious discussion about the collapse of regulation by the Fed. In this column I make the first of what will become four points. First, the consequences of the Fed’s regulatory collapse have proven catastrophic for our Nation. Second, the Fed’s supervisory structure inherently creates a conflict of interest identical to the one that existed in the Savings and Loan (S&L) debacle until Congress and the President decided the conflict was intolerable and eliminated it in 1989. Third, the supervisory culture of the Fed ensures recurrent supervisory failure – and the Fed’s economists are largely responsible for these failures. Fourth, the Fed’s economists’ dogmas and ignorance of fraud mechanisms have combined to create to create intensely criminogenic environments. The Fed does not simply fail to prevent the epidemics of control fraud that cause our recurrent, intensifying financial crises – its policies are so perverse that they aid the fraud epidemics.
The Obama administration, for reasons that pass all understanding, has been running a campaign of leaks disparaging one of Obama’s few senior female appointees, Janet Yellen. Her high crimes include not being a protégée Bob Rubin and doing exceptionally well in economic forecasting. Rubin wants the job of Fed Chair to go to his top protégée, Larry Summers. Yellen, as Vice Chair of the Fed stands in the way of Rubin’s ambitions. (Rubin is too toxic to take the Chair directly.) The administration has been leaking primarily to the New York Times’ Binyamin Applebaum. His latest article contains this remarkable statement, without analysis.
Everyone should read and understand the implications of these two sentences from the 2011 report of the Financial Crisis Inquiry Commission (FCIC).
“From 2000 to 2007, [appraisers] ultimately delivered to Washington officials a petition; signed by 11,000 appraisers…it charged that lenders were pressuring appraisers to place artificially high prices on properties. According to the petition, lenders were ‘blacklisting honest appraisers’ and instead assigning business only to appraisers who would hit the desired price targets” (FCIC 2011: 18).
Those two sentences tell us more about the crisis’ cause, and how easy it was to prevent, than all the books published about the crisis – combined. Here are ten key implications.
The latest effort to blame the Community Reinvestment Act (CRA) for the epidemic of accounting control fraud that drove the crisis is an econometric study by Sumit Agarwal, Efraim Benmelech, Nittai Bergman, and Amit Seru (“the authors”) (“ABBS 2012”). The study does not prove its thesis. The fact that the authors claim it proves causality makes obvious their controlling biases. Their title is “Did the Community Reinvestment Act (CRA) Lead to Risky Lending?” Their abstract answers: “Yes, it did.” They claim that their econometric study proves causality – which is impossible given their methodology. The authors were taught from their freshman years that an econometric study of this nature could not prove causality. Errors this basic and embarrassing demonstrate the crippling grip of the authors’ biases.
A recent study confirmed that control fraud was endemic among our most elite financial institutions. Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market. Tomasz Piskorski, Amit Seru & James Witkin (February 2013) (“PSW 2013”).
The key conclusion of the study is that control fraud was “pervasive” (PSW 2013: 31).
“[A]lthough there is substantial heterogeneity across underwriters, a significant degree of misrepresentation exists across all underwriters, which includes the most reputable financial institutions” (PSW 2013: 29).
The central insight of the sectoral balances model of the economy is that not all sectors of the economy can net-save at the same time. That means that if all those of us in the private sector in aggregate want to (on net) take in more money than we spend, then some other sector will have to spend more money than it receives. In a simple three sector version, the three sectors are the domestic private sector, the government sector, and the foreign sector.