Month: April 2011

“It’s All Relative”

By James Kwak

I finally saw Inside Job at a friend’s house tonight. I don’t have anything original to say about it. I thought it was a very, very good movie. There were lots of little things that weren’t quite right (many of which were probably conscious decisions to simplify details for the sake of comprehension), but I don’t think any of them were substantively misleading. I wouldn’t have made some emphases or drawn some connections that Ferguson did. For example, the parallel between the rise of finance and the decline of manufacturing at the end felt a little shallow to me, not because they’re not related, but because the causality could run down any number of paths. But everyone would tell the story a little differently. Overall I thought it was both a relatively accurate narrative of what happened and a compelling explanation of why it happened.

My favorite scene was when the interviewer (Ferguson, I assume) asked Scott Talbott, the chief lobbyist for the Financial Services Roundtable, about the “very high” compensation in the financial sector. Talbott said something like (I may not have the words quite right), “I wouldn’t agree with ‘very high.’ It’s all relative.”

Made-Up Definitions

By James Kwak

Many commentators who want to blame Fannie and Freddie for the financial crisis base their arguments on analysis done by Edward Pinto. (Peter Wallison bases some of his dissent from the FCIC report on Pinto; even Raghuram Rajan cites Pinto on this point.) According to Pinto’s numbers, about half of all mortgages in the U.S. were “subprime” or “high risk,” and about two-thirds of those were owned by Fannie or Freddie. Last year I pointed out that Pinto’s definition of “subprime” was one he made up himself and that most of the “subprime” loans held by Fannie/Freddie were really prime loans to borrowers with low FICO scores. Unfortunately, I made that point in an update to a post on the somewhat obscure 13 Bankers blog that was mainly explaining what went wrong with a footnote in that book.

Fortunately, there’s a much more comprehensive treatment of the issue by David Min. One issue I was agnostic about was whether prime loans to people with low (<660) FICO scores should have been called “subprime,” following Pinto, or not, following the common definition. Min shows (p. 8) that prime loans to <660 borrowers had a delinquency rate of 10 percent, compared to 7 percent for conforming loans and 28 percent for subprime loans, implying that calling them the moral equivalent of subprime is a bit of a stretch. Min also shows that most of the Fannie/Freddie loans that Pinto classifies as subprime or high-risk didn’t meet the Fannie/Freddie affordable housing goals anyway — so to the extent that Fannie/Freddie were investing in riskier mortgages, it was because of the profit motive, not because of the affordable housing mandate imposed by the government.

Min also analyzes Pinto’s claim that the Community Reinvestment Act led to 2.2 million risky mortgages and points out that, as with “subprime” loans, this number includes loans made by institutions that were not subject to the CRA in the first place. Of course, the CRA claim is ridiculous on its face (compared to the Fannie/Freddie claim, which I would say is not ridiculous on its face) for a number of reasons, including the facts that only banks are subject to the CRA (not nonbank mortgages originators) and most risky loans were made in middle-income areas where the CRA is essentially irrelevant.

Mainly, though, I’m just glad that someone has dug into this in more detail than I did.

Institute Of International Finance Wins Two Nobel Prizes

By Simon Johnson

In a surprise announcement early this morning, the 2011 Nobel Peace Prize and the Nobel Prize for Economics (strictly speaking: “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”) were simultaneously awarded to the Institute of International Finance (IIF), “the world’s only global association of financial institutions”.

This is the first time the Economics Prize has been awarded to an organization – although the Peace Prize has been received by various institutions (including the Intergovernmental Panel on Climate Change, the International Atomic Energy Agency, and Lord Boyd Orr – in part for his work with the Food and Agriculture Organization).

In its citation for the economics prize, the Royal Swedish Academy of Sciences said the IIF won for its work on capital requirements for banks, which proved that requiring banks to fund themselves with positive equity – and therefore have any kind of buffer against insolvency – would limit credit, be very bad for economic growth, and generally make all consumers less happy.  Based on this single remarkable paper, the IIF earned the prize for its: Continue reading “Institute Of International Finance Wins Two Nobel Prizes” →