07
Oct
08

A glib dilettante explains the credit crisis, part 1

So now that the House has caved on this latest piece of corporate welfare, let’s have a look at just what the fuck’s going on with all these banks screaming like teenaged shoplifters in a prison shower block.

When cheap mortgages go bad

First of all, just what exactly is the problem?  Simply put, a bunch of banks and other “lending institutions” (things like Fannie Mae and Freddie Mac) are in deep, deep shit.  Some of them are in deep shit because they sold folks high-risk mortgages on dubious premises (my favourite is the “NINJA” — “No Income, No Jobs or Assets” — mortgage), and when the housing “bubble” burst that credit turned out to be worth roughly fuck-all squared*.  Most of the rest are in deep shit because they invested in the first banks, having decided that securities backed by ridiculously bad credit were a pretty good buy if they were cheap enough (and they were).  The remainder are in trouble simply by association with the first two groups.

You’ve surely heard the idea that if you owe the bank a million dollars, you’re in trouble; but if you owe the bank a few billion dollars, the bank is in trouble.  Turns out that if the banks owe — well, each other, or us, or someone — a few trillion dollars, everyone’s in trouble.  So here’s my take on why, and in particular, why you shrill jackasses on both sides of the usual left-right fence are fucking wrong.

Wait, no; that’s not fair.  In a sense, you’re both right.  It’s a very small sense, but it’s there.  Sort of.

Government fucked up, and “the market” went cheerfully along for the ride

Most people on the Left with a keyboard and an axe to grind are calling this a watershed example of market failure, in much the same way that the British destruction of the Italian fleet at Taranto was a watershed example of air power beating the shit out of battleships.  Well, yes, the credit market failed — but in a drearily predictable way which says as much about free enterprise as Hitler’s appointment as chancellor in 1933 says about democracy.

On the other hand, most people on the Right (with a keyboard and an axe to grind) are pointing accusatory fingers at everything from the Community Reinvestment Act to a vaguely-defined national sense of socialistic entitlement, and telling everyone who’ll listen that the credit crisis stems from gummint(!) forcing banks to issue eight hundred thousand dollar mortgages to everyone who asks, even ne’er-do-well day labourers who’ve immigrated illegally from Mexico.  Well, yes, the feds did mandate — or at least encourage — banks to issue loans based only glancingly on people’s ability to repay them… but poor people with mortgages aren’t the root of the problem, there’s far more going on than the CRA and its sketchy-looking friends, and that still doesn’t explain why everyone and s/h/its dog jumped on the stupid investments I mentioned earlier.

Oh, and y’all non-American readers who’ve made it this far without snickering so hard you’ve destroyed your monitor?  Your banks are just as responsible as American ones for driving up demand for — thus the price of — those investments, and your economies are in the same ocean of shit (though perhaps not quite as deep).  There’s also less you can do about it.  Pleasant dreams.

By political ideology, I’m a libertarian, so in this case I’m awfully tempted to side with those smarmy pricks on the Right and simply blame government for this whole mess.  Sadly for me (it would be so easy!) but happily for the rest of you, I’m also a scientist, and I’ve been bitch-slapped enough by reality to recognize its authority over ideology.  Therefore, I’m going to try to dig through the rich bullshit surrounding the credit crisis and figure out just what the fuck’s going on.

If you reward bad decisions, that’s what you’ll get

First of all, let me remind you of something I mentioned previously: rational agents.  Among other things, a rational agent is one which reacts to incentives.  A rational agent will also bear in mind constraints upon it, and will consider the future consequences of its actions.  (The latter two don’t sound much like either a government or an investment bank, but that’s mostly because governments and banks are Byzantine organizations composed of thundering herds of people, rather than individual agents themselves.)  As Tim Harford argues — fairly convincingly — in The Logic of Life, people in particular aren’t perfectly rational, but taken in aggregate, they tend to act pretty damn rationally in the average.

The key word here is incentives.  To figure out just how we fucked up this time, not to mention how to get out of this particular world of shit and how to avoid fucking up the same way in the future, we need to look at why people did the stupid shit they did — be it buying mortgages with nothing to back it up, or selling mortgages to people with no obvious way to pay them off, or buying securities based on questionably-backed mortgages.  The problem with incentives, as we’ll discover, is that when you provide what seems to be one fairly innocuous incentive (lowering credit requirements on mortgages to encourage poor folks to buy houses, say), you tend to create a whole fuck-ton of unwanted and mostly disastrous incentives (to pick just one example, the idea that you can make a quick buck by buying a house on a dirt-cheap mortgage, painting the bathroom and replacing the kitchen floor, then selling it at a $10,000 profit to some other peckerhead who wants to make a quick buck by buying a house on a dirt-cheap mortgate and &c.).  This propagation of incentives — roughly speaking, what we hard-science types call emergent behaviour — is in a nutshell why communism always seems to end up killing millions of people.

Here’s how things are going to work out: First, I’m going to explain why presumably well-intentioned government regulations engineered a shit-pot of awful credit by encouraging — actually, this is one of those rare occasions where incentivizing is more clear — people to buy bad mortgages.  Next, I’m going to explain how that awful credit got fucking everywhere in the world market.  Finally, I’m going to tell you that I have no fucking clue what to do about it, and haven’t the slightest confidence that anyone else does either.

(Continued in A glib dilettante explains the credit crisis, part 2)

——

* Fuck-all is obviously very close to zero, so fuck-all squared is far closer to zero than that.


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