Sorkin – Right, Gelinas – Wrong Today, Krugman – Wrong as Usual
Sorkin has the politics of this exactly right
Arguing over the street address of the consumer financial protection agency makes the GOP look dumb and on the take. (Sort of like real life.) There are really principled and therefor persuasive arguments against a consumer agency, like “consumer protection” in the form of forcing banks to make rotten loans is what started this whole mess, but the GOP seems impervious to them.
We Love Nicole Gelinas, but we just don’t buy it
For Gelinas, the decisive factor in banking over the past two decades has been “moral hazard”, the belief that if too-big-too-fail banks get in trouble the government will bail them out. This, she argues, encourages the banks to behave recklessly because they are playing with the governments money.
As we have written elsewhere this is implausible as an explanation of the behavior of senior bank executives, who surely do not go around deliberately making reckless loans because the government might bail them out. Senior execs are mostly major stockholders and stockholders typically are not preserved in bailouts. That makes moral hazard an economically implausible explanation for banker behavior, but it is also psychologically implausible. The CEO of a great bank is capitalist royalty. Most are passionately proud of what they have achieved, the institutions they have built. Does it seem likely that they would recklessly endanger their children. Read Andrew Sorkin’s astounding chronicle of the crisis, Too Big To Fail and tell me when you get to the part where Dick Fuld, who drove Lehman into the ground, says “easy come, easy go, at least it was just government money.” Doesn’t happen.
More subtly, Gelinas and other advocates of the moral hazard thesis argue that it’s really the bond holders that matter. Bond holders, reassured by the government’s implicit backing for the banks, accept lower yields on bank bonds than they would otherwise, allowing the banks to expand their balance sheets and extend credit beyond reason. This is certainly more plausible; indeed it must be partly true. And if a firm like Citibank gets even a 25bps break on the cost of money the total annual subsidy is huge.
But it would be wrong to conclude that bondholders are blasé about the possibility of bank failure. The commercial banks borrowed at a considerable premium to the rates paid by Fannie and Freddie, whose government guarantees were much more firm. If bank bondholders really felt that lending to commercial banks was a risk free proposition those banks would have been able to buy even cheaper. In any event, since bank executives were at risk, why should they behave recklessly just because bondholders were renting their money cheap.
The real reason the banks as well as Fannie and Freddie got into trouble was not that they behaved recklessly, but they believed the “structured” mortgage finance was a great idea, and far safer than the traditional lend and hold mortgage business. So did the regulators who, far from being too passive, actively encouraged the new-fangled mortgage market. So did the professors who taught regulators and bankers alike.
Not every problem is caused by bad policy. A society, or a business sector, in thrall to bad ideas will do bad things.
Krugman Hoist on Own Petard (Couldn’t happen to nicer guy)
Tags: Andrew Redleaf, bankers, banking crisis, banking deregulation, capitalism, gelinas, krugman, Mortgage Crisis, Regulation, Richard Vigilante, sorkin, Whitebox, WSJ
