There are three fundamental differences between the financial crisis of three years ago and today’s events.
Starting from the most obvious: The two crises had completely different origins.
The older one spread from the bottom up. It began among over-optimistic home buyers, rose through the Wall Street securitization machine, with more than a little help from credit-rating firms, and ended up infecting the global economy. It was the financial sector’s breakdown that caused the recession.
The current predicament, by contrast, is a top-down affair. Governments around the world, unable to stimulate their economies and get their houses in order, have gradually lost the trust of the business and financial communities.
That, in turn, has caused a sharp reduction in private sector spending and investing, causing a vicious circle that leads to high unemployment and sluggish growth. Markets and banks, in this case, are victims, not perpetrators.
The second difference is perhaps the most important: Financial companies and households had feasted on cheap credit in the run-up to 2007-2008.
When the bubble burst, the resulting crash diet of deleveraging caused a massive recessionary shock.
This time around, the problem is the opposite. The economic doldrums are prompting companies and individuals to stash their cash away and steer clear of debt, resulting in anemic consumption and investment growth.
The final distinction is a direct consequence of the first two. Given its genesis, the 2008 financial catastrophe had a simple, if painful, solution: Governments had to step in to provide liquidity in droves through low interest rates, bank bailouts and injections of cash into the economy.
No. Sorry WSJ, but you have part of your story wrong.
First, it is disingenuous to say the 2008 crisis “began among over-optimistic home buyers” and then “rose through the Wall Street securitization machine.” That’s a tidy narrative, but inaccurate and unfair to home buyers. Consider that, for years before the crisis, mortgage-backed securities were already part of the investment bank portfolio—and, given the rates of repayment, a solid bond purchase for investors. It was securitization of mortgages that prompted the rise of the lend-and-sell structure of mortgage originators, who no longer had to hold on to the mortgages they made to home buyers. As originators lost their stake in how loans performed over the long-term, and considering the commission-based pay structure of the industry, originators began making sketchier loans. Investment banks didn’t catch on to the declining quality of the loans, in part because they outsourced this responsibility to credit rating agencies, which had to compete with each other for banks’ business and were therefore more inclined to give out AAA ratings to mortgage-backed securities even as the quality of the assets steadily declined. Take all of this together with the insane rise in housing prices (which, in chicken-or-egg style, was fueled in part by the availability of cheap credit enabled by mortgage securitization) that allowed home buyers to successfully “flip” houses for a profit. Consider also the rise of the interest-only residential mortgage and the rise of refinancing options, both of which were partly enabled by relaxing regulations governing mortgage lending, and which encouraged home buyers to end up “upside down” in their mortgages for a period of time before reselling or refinancing.
To try to wrap all of this nuance up into “home buyers made bad choices and then their mistakes infected Wall Street” is misleading at best. The WSJ, of all papers, should know better.
I’m also unsettled by the last sentence quoted:
“Governments had to step in to provide liquidity in droves through low interest rates, bank bailouts and injections of cash into the economy.”
Well, governments did step in to provide liquidity. What they didn’t do was require real, large-scale mortgage modification to help keep home owners in their homes. Instead, they chose to pursue a set of policy positions to make whole institutions like Goldman Sachs, who had sold mortgage-backed securities to institutional investors (think: pension funds) while effectively selling them short through insurance by AIG. When the government bailed out AIG, it paid Goldman Sachs, other banks, and hedge funds that had bet against the mortgage-backed securities market off in full. No discounts, no haircuts. Meanwhile, the home owners and the bond holders were—and still are—royally fucked.
The government’s decision to give banks such an underhanded and sneaky gift without also helping home owners get right side up in their mortgages is unconscionable. I consider it the greatest single mistake of President Obama’s administration, and I have not forgiven him for it.
(Source: joshsternberg)
