Prometheus 6

Remember Phil Graham?

Yeah, THAT guy. Well, he's back, in the Wall Street Journal Editorial page...just as you would expect. And as the best lies have as much truth in them as possible, Mr. Graham starts with an objective truth:

The debate about the cause of the current crisis in our financial markets is important because the reforms implemented by Congress will be profoundly affected by what people believe caused the crisis.

I don't see a concern for objective truth in that statement...but the statement itself is gospel.

If [people believe] the cause was an unsustainable boom in house prices and irresponsible mortgage lending that corrupted the balance sheets of the world's financial institutions, reforming the housing credit system and correcting attendant problems in the financial system are called for. But if [people believe] the fundamental structure of the financial system is flawed, a more profound restructuring is required.

The second paragraph defines the problem he would solve. I inserted the '[people believe]'s because belief is what Mr. Graham is addressing. He did not say "The debate about the cause of the current crisis in our financial markets is important because the reforms implemented by Congress will be profoundly affected by what caused the crisis."

I believe that a strong case can be made that the financial crisis stemmed from a confluence of two factors. The first was the unintended consequences of a monetary policy, developed to combat inventory cycle recessions in the last half of the 20th century, that was not well suited to the speculative bubble recession of 2001. The second was the politicization of mortgage lending.

And so he sets about explaining what he wants people to believe: that "loose money and politicized mortgages" caused the economic meltdown, the the problem was a unsustainable boom rather that the fundamentals of the way the financial system works. He gets off four decent paragraphs laying the groundwork for his first factor...but we know that second factor is going to be a problem.

Meanwhile, mortgage lending was becoming increasingly politicized. Community Reinvestment Act (CRA) requirements led regulators to foster looser underwriting and encouraged the making of more and more marginal loans.

He had to slide that in there. I am, in fact, shocked to see no mention of ACORN. But this has been so thoroughly debunked that Mr. Graham needed the words of the Wizard of Oz himself for cover.

As Mr. Greenspan testified last October at a hearing of the House Committee on Oversight and Government Reform, "It's instructive to go back to the early stages of the subprime market, which has essentially emerged out of CRA." It was not just that CRA and federal housing policy pressured lenders to make risky loans -- but that they gave lenders the excuse and the regulatory cover.

Thing is, I don't recall Mr. Greenspan even implying such a thing. So you know what I did? I went to the House Committee on Oversight and Government Reform's web site. I went to the Hearings page and found they had four hearings in October 2008, only one of which was attended by Mr. Greenspan. His testimony can be read in this PDF or the transcript of the entire hearing...I suggest the first one, as it's only five pags long.

Nowhere does the phrase "It's instructive to go back to the early stages of the subprime market, which has essentially emerged out of CRA" appear in Mr. Greenspan's testimony.

What IS in Mr. Greenspan's testimony is the following explanation of what caused the financial collapse.

As I wrote last March: those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined.

What went wrong with global economic policies that had worked so effectively for nearly four decades? The breakdown has been most apparent in the securitization of home mortgages. The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of crisis) would have been far smaller and defaults accordingly far fewer. But subprime mortgages pooled and sold as securities became subject to explosive demand from investors around the world. These mortgage backed securities being “subprime” were originally offered at what appeared to be exceptionally high risk-adjusted market interest rates. But with U.S. home prices still rising, delinquency and foreclosure rates were deceptively modest. Losses were minimal. To the most sophisticated investors in the world, they were wrongly viewed as a “steal.”

The consequent surge in global demand for U.S. subprime securities by banks, hedge, and pension funds supported by unrealistically positive rating designations by credit agencies was, in my judgment, the core of the problem. Demand became so aggressive that too many securitizers and lenders believed they were able to create and sell mortgage backed securities so quickly that they never put their shareholders’ capital at risk and hence did not have the incentive to evaluate the credit quality of what they were selling. Pressures on lenders to supply more “paper” collapsed subprime underwriting standards from 2005 forward. Uncritical acceptance of credit ratings by purchasers of these toxic assets has led to huge losses.

It was the failure to properly price such risky assets that precipitated the crisis.

So it seems what Mr. Graham wants people to believe caused the crash has nothing to do with what actually caused the crash.

I'm not surprised. Are you?