Following up on yesterday’s post, this is the best succinct explanation of policy mistakes and their financial effects over the past 5 years I’ve read. From the WSJ:
Rewriting the Lehman Post Mortem
Asset bubbles for the rich and a welfare boom for the rest does not a recovery make…A large share of blame, we’re sorry to add, lies with Mr. Bernanke for continuing to offer up QE without getting anything (say, tax reform) in return from the Obama administration that would actually encourage private-sector growth.
Five years after Lehman it pays to rethink why we had a financial panic and why the recovery has been so slow. The credit crisis, which was already under way before Lehman, was a crisis of a single asset class, Triple-A mortgage derivatives, held by banks with large amounts of borrowed money, which they acquired amid a government-sponsored housing boom.
Yet the government’s own investigating commission would later write that, even as many subprime loans went bad, the Triple-A tranches held by banks mostly “have avoided actual losses” and likely would “avoid significant realized losses going forward.”
All the institutions that were holding these securities that were bailed out by government were able to repay their bailout funds with a profit.
Ben Bernanke, the Federal Reserve chairman, would later testify: “The stock market goes up and down every day more than the entire value of the subprime mortgages in the country.”
Then why did we have a global meltdown?
In insisting the crisis was rooted in something real, the Economist magazine last week claimed bankers mistakenly judged local housing markets an “uncorrelated risk,” but “starting in 2006, America suffered a nationwide house-price slump.” Yes and no. Though we would eventually have something resembling a national housing slump, it was more an effect than a cause of the post-Lehman global financial panic.
For the first 18 months of the correction, recall, employment and housing markets actually held up quite well outside the four states—California, Florida, Nevada and Arizona—where the subprime boom had been concentrated. What caused “uncorrelated” housing markets to become correlated was the event that caused many markets to become correlated—the job market, the stock market. Even the Treasury market became correlated in the sense that, as everything else fell, investors rushed to the one asset they believed couldn’t default. That event was Lehman.
Mr. Bernanke was right: The subprime bubble itself wasn’t a big deal. It was uncertainty about government behavior, once institutions were loaded with illiquid but not necessarily worthless “Triple-A” housing paper, that turned a sharp housing correction in a handful of states into a global financial panic.
Now let’s admit that in any financial system resembling ours, such things will happen. A bank is insolvent when government says it’s insolvent. Under government rules, arguably mortgage securities should have been written down to reflect fire-sale prices prevailing in the market.
In writing them down, banks arguably should have been deemed insolvent under government capital standards.
But, before and after Lehman, Washington resisted actually letting institutions fail. Who doubts, even today, that the Fed’s backing away from tapering isn’t occasioned partly by concern for risks to the financial system? Various memoirists now claim they lacked legal means to save Lehman. But anyone awake at the time knows their real fear was a populist backlash that would undermine the larger bailout project. When Lehman’s consequences were clear, they quickly renewed the blanket guarantee of large institutions.
Today, little has changed in our financial system. The only question is when banks will be imperceptibly driven again by market pressures to test their reliance on an implicit government liquidity guarantee, if they aren’t already.
A separate but related question is why the recovery has been so slow. One view holds that credit crises must always produce slow recoveries, never mind that in the archetypal case, the 1930s, the rebound was actually brisk until anti-business and credit-tightening policies shut it down again.
Today some complain of a “rich man’s recovery,” but isn’t this exactly the recovery our policies have selected for? The rich derive their incomes disproportionately from assets, and the Fed’s explicit contribution has been to boost asset prices. The middle class derives its income mainly from jobs, but jobs have been willingly sacrificed to Washington’s other agendas. Example: a health-care law that punishes companies for hiring more than 49 workers or employing them for more than 29 hours a week.
The tax and regulatory policies of the Obama administration may have their merits, including meeting a post-crisis demand for leftish gestures. But a policy mix, to put it baldly, of asset bubbles for the rich and a jobless welfare boom for everyone else is not exactly going to produce sustainable recovery or a sound financial system. This is a historic failure. A large share of blame, we’re sorry to add, lies with Mr. Bernanke for continuing to offer up QE without getting anything (say, tax reform) in return from the Obama administration that would actually encourage private-sector growth.