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Barney Frank’s Bad Idea

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5 Responses

  1. A.J. Sutter says:

    As I understand it, the problem was not only that the originators were “insufficiently incentivized” to monitor loan quality, but that they were affirmatively incentivized not to do so, given the appetite for risk. But what is your constructive suggestion? Is it to remove the “distortions” in the market (in which case, could you please point out a relevant market that does not have any “distortions” and works the better for it)? Or is it to regulate the “extremely wealthy, extremely sophisticated, extremely large financial institutions” whose extreme size and extreme sophistication screwed up the world’s economy?

  2. ParatrooperJJ says:

    Getting rid of the CRA would have a much better effect.

  3. Nate Oman says:

    Proposals that I would support:

    1. Creating relatively mechanical (and therefore not politically gameable) rules that increase capital requirements with size.

    2. Creating ways of credibly threatening large institutions with failure, for example with living wills and other mechanisms to forestall fears of chaotic failures.

    3. Completely break up the GSEs. Sell their good assets to private banks, and put their bad assets in a “bad bank,” with the goal of eventually winding down its affairs completely.

    4. Shift monetary policy. Part of this is getting a less political Fed that is willing to act more like the ECB. Part of this is technical. Targeting inflation using the CPI, for example, seems to create problems because the CPI doesn’t capture rises in asset prices, which can be driven by monetary expansion. One suggestion that I have heard is that rather than targeting interest rates or the CPI, the Fed should target nominal GDP or some other measure of price volitility that captures swings in asset prices.

    The notion that the crisis resulted from shifty mortgage brokers, however, is ultimately implausible, and I think that potential for upsetting essentially harmless transactions by requiring risk retention is pretty high. Rather than telling fairy stories about agency costs, we need to look at the fundamental question of why there was such a huge appetite for risk. Hint: It wasn’t because fast talking mortgage brokers convinced Bear Sterns to buy their junk. They made the junk because Bear Sterns et al wanted it.

  4. Nate Oman says:

    FWIW, I think that the the CRA is a red herring. In many ways it may have been a bad idea, but it simply wasn’t a big enough program to move the financial markets in the way that we saw in the subprime crisis. The Fed and the GSEs, on the other hand, are another matter…

  5. A.J. Sutter says:

    Thanks for your reply. But I thought that GDP excludes capital gains — how does nominal GDP capture swings in asset prices? Or does it do so only indirectly, such as when I-bankers, traders & al. spend their bonuses?

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