John Allison's book is a helpful look at the government policies that contributed to the housing bubble, the financial crisis, and the "Great Recession". As with the Great Depression, any blame ascribed to markets should be balanced (if not overwhelmed) by the clear damage done to the economy by a series of bad government policies. In this case, contra Ezra Klein
, Allison places primary blame on govt policy that
encouraged a bubble in residential real estate; mistakes by financial
institutions; and lots of bailouts and crony capitalism. (On the latter, he targets AIG and Goldman-Sachs [p. 128-129].)
Allison doesn't discuss the Great Depression at any length. Back then, we had a massive import tax increase (Smoot-Hawley), four tax increases (including a new tax on labor to finance Social Security!), declining money supply (thanks Fed!), price and wage floors (including a new minimum wage, making workers less attractive to firms). The result: unemployment peaking at 25%; GDP shrinking by 1/4 in four years; 10 years of double-digit unemployment; and 19% unemployment in the 6th year of the so-called "New Deal". Very impressive work, gentlemen! It makes President Obama and the current Congress look like a bunch of geniuses.
Allison starts with the assertion that "financial services" is probably the most regulated industry in the world (5). I don't know how one would measure that, but the broader point clearly holds-- that it is a highly-regulated industry. As such, problems in the industry might be blamed in some part on markets, but government has to take (big) responsibility insofar as it exercises (tremendous) power.
Allison also notes that housing is more consumption than investment. Land is more of an investment, but a home will necessarily depreciate and requires maintenance costs. People have gone along with the investment rhetoric-- and the reality that buying is more of an investment than renting. Still, they are confused about the role of inflation in real gains; they see higher prices and imagine that the real value is increasing substantially. Ironically, Allison notes that the change in perspective-- stemming from the Crash-- has further undermined value in that market (73-74).
Mal-investment, as encouraged by the govt, is harmful to society and consumers. On the latter, savings is reduced and it encourages marginal people to move into something they can't afford
. Ouch! As always, you gotta love those good intentions! That is enough, right?
Allison includes some delightful quotes on the FDIC from FDR-- that it would "place a premium on unsound banking" and "involve the govt in probable loss" (37). He said similarly negative things about the disincentives inherent in welfare policies, but his concerns did not carry the day in his decisions. The FDIC is designed to be revenue-neutral overall, but breaking that down: this means that the bad will be subsidized by the good. It also establishes an implicit cartel-- and creates a moral hazard problem for investors and banks. As a prominent example during the crisis, Allison critiques the bailout of Washington Mutual (75-76) in its payment of uninsured depositors in full. "Until the WaMu failure, the idea had been that uninsured depositors would impose discipline on a reckless bank...The FDIC had taken part of the money that should have been available to pay bondholders and given it to uninsured depositors...complete contradiction to past practice...no rule of law...forced the failure of Wachovia..." Allison also describes a private solution, along the lines of what we have in life insurance and in securities (48-49).
Allison is unimpressed with regulators: "in almost every case...govt regulators have been the last people to know...extraordinarily naive...lack of understanding of human nature and the power of incentives...[and] of the information available to [them]...dominated by lifetime bureaucrats [who] follow the rules and not rock the boat...very process-oriented...the best and brightest individuals tend to leave." (41, 46) For effective govt policy, one must have good info and good motives. Without both, you get a mess. Allison devotes all of chapter 14 to the failure of the SEC.
Allison pursues an aside on discrimination in lending (42-43): "leave themselves tremendous leeway to interpret their own regulations...extremely political...no objective rule of law..." He describes the usual, profit-mongering incentives for banks to loan green to good risks, whatever the color of the applicant. (Are they greedy or not? I get mixed up on this.) And he points to the poor/univariate empirical work that seemed to show discrimination, before citing the careful work that controls for more variables and causes the apparent discrimination to disappear. But after the focus on discrimination and the bureaucratic and legal heat (he shares BB&T's story on 44-45), risky lending to minorities increased-- good news for them short-term, but not for many of them in the long-term. Ahhh, but we had good intentions.
The carrot of general subsidies for risky lending and the stick of penalizing those who didn't seem to loan to enough minorities created unfortunate incentives and results: "encouraging people to buy homes that were too big, to speculate on housing based on govt incentives, or to buy houses that they could not afford..." There were other ethical problems too: subsidizing the wealthy; subsidizing a particular lifestyle choice (owning), supporting consumption over investment, and subsidizing residential real estate over other sorts of investment (54-55).
Allison argues that Fannie Mae & Freddie Mac (F&F) should not exist, let alone dominate the housing market. He notes the destruction of the S&L's industry through govt policy (96-97) and notes the emergence of F&F as dominant players in the wake of that disaster (97). Allison is particularly upset that F&F did not report their $2 trillion in subprime loans. They "funded a major percentage of the misinvestment...and provided materially misleading information that contributed to errors by other market participants." (61, 64-65). F&F, given the moral hazard of a guaranteed bailout engaged in risky loans, encouraging if not requiring the same from competitors: "a competitive race to the bottom" (100).
One bit of institutional knowledge I learned: the bond-ratings agencies are a govt-sanctioned oligopoly-- explicitly for ERISA, but then implicitly through the federal imprimatur (81-82). They did a terrible job and there was no competition to correct this or hold them accountable-- an utter failure and fraud
(82). Within the oligopoly, the incentives were twisted: agencies used to be paid by buyers, but then were paid by sellers-- a BIG difference! (83-84)
Allison also describes a lending practice I had not heard described: "pick-a-payment" (89-91)-- where buyers paid LESS than the interest payment. This works well if the value of the home increases enough-- as increasing home equity offsets the loss in equity from insufficient payments. What a joke!
He covers the myths surrounding the exaggerated role of derivatives (122-123). They were too small to be a major player. Some/many were used to reduce risk rather than engage in speculation. And they are zero-sum. Likewise, he demolishes the amazing myth about banking deregulation during the Bush Years in chapter 13. Instead, there were three major financial regulatory efforts: Privacy Act, Patriot Act, and Sarbanes-Oxley. See: Daniel Mitchell vs. Paul Krugman
He has a good description of the pros and cons of "fair-value accounting" in chapter 11.Allison wrestles with the likelihood and type of market correction we would have had without so much intervention (ch. 15)-- especially TARP (ch. 16). And he closes with explicit policy RX's (chs. 17-20, 23); a discussion of the relevant, underlying philosophy (chs. 21-22) and ch. 24's call to principled action in all realms.
I don't know enough about the relevant industries and regulators to say whether Allison provides the definitive account. But it makes sense in light of economic incentives and it lines up with the usual problems one finds with government-- regulation, cronyism, good intentions, and so on.