The Craziest Claims Yet about the Credit Crisis

The credit crisis has provided ample opportunities for foolishness. Certainly California Republican Darrell Issa’s claim that the House bill would have been a “coffin on top of Reagan’s coffin” was an oddly necrophilic bunkmate to President Bush’s penetrating insight that “this sucker’s going down.”

But the prize for crazy claims about the credit crisis must go to former Dallas Fed President Bob McTeer, whose Monday post on the New York Times’ Economix blog claims that: (i) Wall Street banks were the real victims of the crisis; (ii) the real villains were minorities; and (iii) the only thing needed to fix the crisis is to change accounting rules.

I kid you not.

Let’s consider each in turn.

1. Banks are Victims

“[A]ll the focus on C.E.O. salary caps,” he writes “implied that the holders of illiquid mortgage-backed securities were the villains in this drama rather than the victims. They didn’t package the securities, or sell them; they bought them as an investment.”


Excuse me? I didn’t get that.

Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs, Citibank and many others now in or near trouble did not package or sell these securities? Perhaps the league tables were just lies?

The reality, of course, is that investment banks were both issuers and purchasers. That was the point: To keep the paper moving as fast as possible, hoping that once the music stopped, there would still be a seat. No one realized (or admitted) that this game of musical chairs was being played on the deck of the Titanic.

2. It’s Minorities’ Fault

The real villains, McTeer would have us believe, are minority borrowers. This was because “the government had encouraged the purchase of mortgage-backed securities by giving banks C.R.A. (Community Reinvestment Act) credit for securities that contained mortgages made in ZIP codes.” While he concedes that this lending may not have played a “decisive” role, the implication is clear: It was lending to people who look like, you know, Barack Obama, who are really to blame here.

This is truly outrageous. There is not a shred of evidence that CRA-based lending had anything to do with the credit crisis. The CRA is an extremely weak piece of banking legislation that in theory requires banks to lend in their “communities,” which has usually (albeit mistakenly) been taken to mean “minority” communities. Excess liquidity doubtless resulted in mortgage lending to all sorts of bad risks, including minorities. But it wasn’t the CRA that caused this.

And, while it is true that a disparate amount of subprime lending was to African Americans, it wasn’t by banks. It was by non-bank originators like Countrywide.

You would expect a former Fed branch president to know this.

3. The Magic Cure: New Accounting!

To the extent the credit crisis is not the fault of minority borrowers, McTeer appears to believe it was caused by “mark to market” accounting rules that forced holders of toxic securities to write these assets down if they couldn’t offload them quickly. This is not really McTeer’s insight. Many, including William Isaac, who was the F.D.I.C. chair during the S&L crisis, believe this was a critical part of the problem, since it forces lenders to declare something valueless simply because it is illiquid, which really doesn’t make much sense.

I am not an accountant, so offer no opinion on whether this is true. But what McTeer doesn’t bother to tell us is what should now replace it? “Marking-to-model?” That got us into this problem in the first place, because it enabled sponsors—you know, McTeer’s victims—to claim unrealistical valuations and amortization rates for the securities they issued. Should we go back to that? How would that revive the market for these securities? If you add zeroes to the balance sheet, will the credit market miraculously revive?

4. Who IS this Guy?

McTeer is not only a former President of the Dallas Fed. He has a PhD in economics from the University of Georgia, is a former of Chancellor of Texas A&M, and self-published poet. He is a zealous free marketeer, whose insights include this: “The market system features consumer sovereignty, meaning that the consumer is king. We decide what will be produced by casting dollar votes for the things we want and by not spending on the things we don’t want.”

That may well be true–in a world where people have dollars that are worth something. So far as I can tell, his version of the free market has gone a long way to making sure that we have fewer dollars, and those we have are weaker.

He is also a management guru who’s maxims include this mind-bender: “Too long” and “too short” appear to mean the same thing. Go figure.”

Perhaps he’s right. Only a man who thinks opposites are identical could believe investment banks are victims and minority borrowers villains.

You may also like...

13 Responses

  1. JP says:

    McTeer has a comment that responds to criticism similar to yours here.

    I agree that calling bank CEO’s the “victims” is crazy. That said, I think you’re wrong to suggest he’s blaming the crisis on “minority borrowers.” Maybe he blames it in part on ‘institutions that lent money to poor people, with the governments encouragement,’ but I think you are stretching pretty far to implicitly accuse someone of racism. I read his post as making the point (raised by many others) that it is hypocritical for Congress to vilify institutions that issued or purchased risky loans after years of Congressional policy encouraging those same loans.

    (Relatedly, doesn’t your point 2 contradict point 1? If non-bank institutions like Countrywide* originated the bad loans, and then sold them to banks as investments, isn’t that exactly what McTeer was claiming? [*Is Countrywide a “non-bank institution?” I thought Countrywide had a banking operation that did the securitization?]

    Also, McTeer does (I think) suggest an alternative to mark-to-market. (Of course, since he’s only suggesting suspension or relaxation a replacement wouldn’t be quite right.) The Forbes article he links suggests something about keeping the assets on the balance sheet but holding them to maturity. I assume this is consistent with the WSJ article by Mr. Isaac that he links which recommends marking assets to their true economic value.

  2. Humblelawstudent says:

    I don’t pretend to understand all of this, but your point 2. seems questionable.

    First off, were non-bank originators like Countrywide not under similar pressure to increase the number of loans to minority communities and in particular to African Americans?

    Second, the enormously disproportionate sub-prime lending (52.44% from your source) to African-Americans suggests that race was strongly a factor influencing banks and non-bank originators.

    Roughly half of the subprice mortgages came from banks, and half not. Unfortunately, your source doesn’t break down the lending based on source. So, it is hard to figure out much more.

  3. Jonathan Lipson says:

    I won’t waste too much bandwidth here, but as stated, there is no meaningful evidence that the CRA caused the predatory lending to minorities that now accounts for such high default rates among African American borrowers. For more on this, see http://www.newamerica.net/blog/asset-building/2008/no-larry-cra-didn-t-cause-sub-prime-mess-3210.

    It is true that default rates among minority borrowers is high, but the evidence seems to be that this is because many were pressured into loans that were entirely inappropriate for them. To claim that the CRA caused this is wrong.

    For that claim to be true, this sort of lending to minorities would have to have occurred before the liquidity glut–which it did not. For it to have been true, the CRA would have to apply to the many non-depositary institutions that were originating these loans–which it does not.

    Make no mistake–there was pressure to make bad loans. But it was pressure that originated with the wall street investment banks who are now being bailed out, not the CRA. They created the securitization structures that (incorrectly) purported to disperse risk. While it may be somewhat simplistic, Moulo and Padilla’s “Chain of Blame” (http://www.amazon.com/Chain-Blame-Street-Caused-Mortgage/dp/0470292776) tells this story better than I could.

    I agree that there was widespread, profligate borrowing by lots of people (including minorities), and there is plenty of blame to go around. But to say that the CRA had anything to do with this is misleading and disingenuous.

    Since CRA is code for “minorities” for many on the right–who hate the CRA–I stand by my claim that McTeel’s insinuation–which he lacks the courage to say plainly–is that minorities are the real villians here. Given the real history here, that is simply outrageous.

  4. Humblelawstudent says:

    Nice try with the racist card, but your argument is laughable.

    The argument isn’t that it is the “minorities’ fault.” The argument is that the villian is the people and institutions that pressured banks to extend loans to people (of whom many were minorities) who could’t afford them. The argument may or may not be right, but it is hardly racist.

  5. amused says:

    It is true that default rates among minority borrowers is high, but the evidence seems to be that this is because many were pressured into loans that were entirely inappropriate for them.

    What evidence? Were they “pressured” into “inappropriate” loans because they were minorities? Pressured by whom? How? Why?

  6. Frank says:

    Both “amused” and “humble law student” might want to take a look at the Bush Administration OCC’s aggressive efforts to scuttle state laws prohibiting predatory lending. Here’s a good place to start:

    http://www.responsiblelending.org/policy/testimony/page.jsp?itemID=28632910

    There were people trying to stop this Ponzi scheme of fraud from taking off. They just happened to run into a deregulatory juggernaut.

  7. amused says:

    There were people trying to stop this Ponzi scheme of fraud from taking off.

    What exactly is a “Ponzi scheme of fraud” here? Lending to people with poor credit? Lending to minorities? Securitizing mortgages? Hedging? How does the administration’s opposition to “predatory lending laws” (most economists of both parties oppose those laws) constitute evidence that minorities were more likely to default than whites because minorities were “pressured” into “inappropriate” loans?

    And I am still waiting for “evidence” from Lipson.

  8. Jonathan Lipson says:

    Well, this certainly does get people excited.

    The rather incongruously named “humblelawstudent” claims:

    “The argument is that the villian is the people and institutions that pressured banks to extend loans to people (of whom many were minorities) who could’t afford them. The argument may or may not be right, but it is hardly racist.”

    No dispute. But that’s not the point. As previously explained, and as noted in the cites collected below, many continue to perpetuate the myth that minority lending *caused* the crisis. That’s what strikes me as racist.

    If McTeel has retracted his claim, good for him. Others, as you can see from these links (and the links they collect), have not. http://www.marginalrevolution.com/marginalrevolution/2008/09/did-minority-le.html; http://yglesias.thinkprogress.org/archives/2008/09/cra_once_again.php. Another good study that focuses on the role that predatory lending played in minority communities–and the connections to Wall Street–appears here http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1083184. I think Frank Pasquale’s excellent post today (http://concurringopinions.com/) and the work to which it cites, also illuminates some of this. (So, “amused,” your wait for “evidence” is now over.).

    As I noted here, and as I am always happy to note when discussing this, there is **plenty** of blame to go around–including greedy borrowers, conflicted mortgage brokers, irrationally exuberant home builders, complicit appraisers, etc.

    But taxpayers are not spending $700 billion to bail those guys out. We are bailing out the investment banks (and, in a different context, GSEs) that created the structures that were, at the end of the day, the pool from which this toxic liquidity flowed. I am not sure we have a choice given the state of the credit markets.

    But saying, as McTeel did, that bankers are the victims (a claim he has apparently not retracted) or that the CRA or minority borrowing caused this (which others persist in making), is what is truly “laughable.”

  9. JP says:

    Jonathan,

    Please correct me if I’m wrong, but I think you’re making a pretty fundamental mistake here. You argue that the CRA had no effect because it applied to banks, and not the originators that made the bad loans. You also argue that the originators were pressured by the banks to make the bad loans.

    But if the CRA gave banks credit for owning mortgages from low- and moderate-income communities, and the banks (and GSEs) in turn “pressured” (presumably by increased demand) non-bank originators to make these loans, it seems like there is a pretty direct causal effect between the CRA and sub-prime loans.

    You link to Tyler Cowen, who states that “[policies such as the CRA] contributed to our current problems by only a small amount.”

    As you (and McTeel) note, there is plenty of blame to go around. It also seems likely that McTeel was wrong to highlight the CRA as he did (implicitly claiming that it was a substantial cause). But I haven’t seen any claim that the CRA was THE cause of the crisis, and I still don’t see how the claim that the CRA was a contributing factor is definitively wrong, much less racist.

  10. just one more reason why I could never be a law professor – an inability to find rascism in everything I disagree with.

  11. bill says:

    If minorities are poorer than average, and have less savings to fall back on, doesn’t it make sense that, during the leading edge of an economic depression, they would make up a disproportionate share of mortgage defaults, ceteris paribus, regardless of what kind of mortgages are offered on a society-wide basis?

    Just sayin’, doggone it, y’know, ya betcha.

  12. amused says:

    If McTeel has retracted his claim, good for him. Others, as you can see from these links (and the links they collect), have not. http://www.marginalrevolution.com/marginalrevolution/2008/09/did-minority-le.html; http://yglesias.thinkprogress.org/archives/2008/09/cra_once_again.php. Another good study that focuses on the role that predatory lending played in minority communities–and the connections to Wall Street–appears here http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1083184. I think Frank Pasquale’s excellent post today (http://concurringopinions.com/) and the work to which it cites, also illuminates some of this. (So, “amused,” your wait for “evidence” is now over.).

    Lipson: Please explain which of these links provide support to your claim that

    It is true that default rates among minority borrowers is high, but the evidence seems to be that this is because many were pressured into loans that were entirely inappropriate for them.

    I didn’t ask you to link to a blog post disagreeing with someone else’s wacky conspiracy theory. I asked to provide evidence, which you claimed you had, for your own wacky conspiracy theory. And please make it evidence, not blog commentary. So, still waiting.

  13. willyrave says:

    Of course it takes some time for the economy to recover after the crisis. Country will not feel this positive effect immediately as soon as economy rises. Stock up with patience, use http://sterlingstore.co.uk/payday-loans-no-credit-check.html if needed and keep working hard to make the process faster.