Charles Calomiris says that it is the political system.
There are two important systemic threats to financial stability: government policies that subsidize mortgage risk, and government policies that insure bank debts (and, more generally, that subsidize bank default risk through a variety of channels, including—but not limited to—“toobig-to-fail” protection).
As you know, I have some simple solutions to the problem of subsidizing mortgage risk.
1. Do not provide government guarantees or subsidies for investor loans, meaning mortgages on non-owner-occupied homes. I have linked to a study that found that over one third of mortgage lending in 2006 went to people who were buying a house in addition to the one that they occupied.
2. Do not provide government guarantees or subsidies for loans that extract equity from homes, including second mortgages and cash-out refinances.
These simple, logical steps would have been sufficient to prevent the financial crisis of 2008. However, they would be fiercely opposed by industry trade groups, such as the Mortgage Bankers Association.
Neither 1 nor 2 would have had any effect whatsoever on the housing bubble.
What would have had an effect would have been the use of the regulatory powers given to government over the investment banks.
Almost worthless to mention this in here, but the GSEs did not cause the bubble. The only people who think so are either brain dead stupid or made blind by their ideology.
Have you ever tried backing up your assertions with arguments? It’s really fun.
I have put them in here many times over the year. Somehow, the facts do not work well in here. I think that can be explained by the fact you want me to show my work(which I have many times in the past), while not making the same demand on Mr. Kling.
Read the FCIC report
Read Mike Konczal on the housing bubble
Look at default rates (https://www.americanbanker.com/opinion/gse-critics-ignore-loan-performance)
It would also help if there was a basis of knowledge regarding GSE guidelines, particularly CLTV limits.
When your solution to every problem starts and ends with the government, you don’t have the time for facts that conflict with your solution.
I would define systemic risk as the risk of cascading failures. Unfortunately, the vast majority of financial innovation over the past 30 years has been devoted to how to spread risk as widely as possible, while providing mechanisms to offload profits to specific actors along the way.
So that was what caused the Great Depression. Hardly likely since they didn’t exist, but that’s the problem with faster than light travel, it really screws up causality.
Well, it is not like there were economic depression before The Great Recession. Also, looking back to 2004 – 2005 during the Bubble height years, we don’t see a lot of evidence these banks and financial institutions understood the dangers of the market bubble and that they would be bailed out. We have remember some names did disappear, Countrywide, Wahovia, WaMu and Bear Stearns did disappear so there was lots of losses here.
In fact, didn’t the CATO Institute write the mother of all opinions in 2006 that the banks, especially Fannie & Freddie, should be able to buy deeper credits? So unless CATO deals with that article opinion, it is hard for me to believe this Tuesday morning quarterbacking when their Friday morning game plan was really bad.
I certainly like your two ideas (in my words): 1) gov’t interest deduction only to owner occupants, and 2) no deductions for extracting equity out.
Tho I write the more usual IRS used “deduction” rather than the academic, arguably more accurate but certainly less clear, “government guarantee or subsidy”.
My own solution focus would be to replace deduction of interest with deduction of whole house payment, both interest and principal. With an annual maximum (of $50k/ year), PLUS a lifetime maximum of $500k — to be increased (adjusted) each year to be 10 times the prior year’s median tax income (or 3 yr avg).
I strongly believe that gov’t support for home ownership has been a huge boon to the USA, and to the middle class. But, as noted in this post and the full paper, there have been abuses.
I also like the note in the paper that other, more complex issues are talked about often to obfuscate these more clear issues. Calling out the obfuscation is an excellent and important function many blogs can help with.
1. This might be counterintuitive, but I would require all mortgages to be non-recourse. The point of it would be to make the bank face all of the exposure to declines in home prices, and therefore encourage more prudent behavior on the front end.
2. I’d require maximum LTVs of 80% on any mortgage sold for securitization. Any loan without this feature can be put back to the originator at par.
3. I’d greatly simplify banking capital requirements, requiring a fairly high minimum ratio, simply calculated (e.g. equity must be >10% of book assets), and a significant amount (e.g. >5% of book value of assets) of CoCos that would all be triggered if capital ever fell below this level (perhaps it would be good to pay management partially in these CoCos). In practice, most banks will give themselves a nice cushion above the 10% minimum. In conjunction, I’d get rid of regulatory stress testing.