tv American Enterprise Institute Conference on 2008 Financial Crisis CSPAN September 14, 2018 1:46pm-4:37pm EDT
of financial institutions at columbia business school. and a professor at columbia's school of international and ublic affairs. he's a distinguished fellow at the hoover institution a fellow at the manhattan institute a member of the shadow open market committee, and financial economist round table. we're lucky he could make it today. we received a b.a. in economics and a ph.d. from stanford. charles? ewline] charles: charles: i thank you for joining us. i'm sure you join me in
expressing appreciation for the first panel. my first slide talks about the difference when we use the word cause between an active sense of cause -- i have to press the button? there it is. between an active sense of causeation that is essential ingredients if they hadn't happened, the crisis wouldn't have occurred from a different kind of cause which is, if after things had started to go bad, if people had not been so passive, had intervened, it would not have happened. i want to talk about those two about how i think about causeation in the crisis. i think they're two separate categories. the first one, i want to do a quick review of what i think are the main candidate arguments for the precipitator active causes. the first thing i think that needs to be said is that a very popular view, which i'll called
he mincekey-kindleberg erroler coaster of human greed view, says that crises are always happening everywhere in some great e're also in the phase or fear phase. that is wrong as an explanation of this crisis and all previous crises. and the reason it's clearly wrong is that it predicts that crises happen sort of equally in all eras and all countries. but that's not true. banking crises haven't happened at all in some countries ever. canada is one. and banking crises are much more frequent in some eras than in others. in the last 40 years, we've had over 100 major banking crises. in the 40 years briar to world war i, we had -- prior to world war i, we had about 10. and i would say of those only six were really significant crises in terms of severity.
so the world is not constant even though human behavior and human greed and fear are. so we have to look a lot deeper for crises than just the craziness of markets. that's one of the challenges. i think there are three obvious candidates and we have heard about them today. they are government active subsidization of mortgage risk through a variety of means that makes the mortgage market riskier. second one is a failure of prudential regulation. i want to separate that from deregulation. deregulation is not a plausible ex-play nation for the crisis but fail wrur of prudential regulation is and it requires significant and serious study. the third one is i think the most obvious candidate again which was discussed today is monetary policy. especially with an emphasis on the loose monetary policy from 2002 to -- from 2002 to 2005.
but in talking about causality of these active -- in this active sense, i also want to remind us what aristotle taught us, which is the first person to really seriously address causality as an empir cyst and that is you have to distinguish between proximate and ultimate causes. these think three things i mention are proximate causes. but we have to ask, if we want to understand the world that we're living in and what we could do to make things better, we have to also understand the ultimate causes. so i would say government subsidies for mortgage risk are an outcome. they're not a one of a kind thing, sui generis we just saw for the first time, they're something we can study and understand as a political outcome. is if we want to understand government subsidies for mortgage risk we have to think about them politically. we just heard from jeb hensarling pretty discouraging
discussion of how hard it is to change this dimension of public policy. and i want to spend some of my time today talking about that. regulatory failure is also an outcome. and i want to emphasize, i think the same kinds of political factors that give you mortgage risk subsidies also give you regulation that says that mortgages are half as risky as commercial loans. isn't that part of the subsidy? and that decide also when to press banks to recapitalize during a mortgage crisis and when not to. so regulations is very much a politically driven jut come. i'm going to talk a little bit more about that in -- in a minute. monetary policy, i'll say of course monetary policy sometimes is highly politicized. in my own view i don't understand a political theory of the monetary policy failure of 2002 to 2005.
allen meltser in his 100-year history of the fed, pointed out there are two kinds of every rrs that have typically underrain fed policy failure. the one is politics and the other is bad thinking. and i think that in this case, bad thinking wins the prize. over poll techs. for explaining monetary policy. i want to just focus a little bit then on the politics of mortgage risk subsidization which includes failure of prudential regulation to prevent mortgage risk subsidization. notice that you can't really have a subsidization of mortgage risks if ultimately the financial institutions that are issuing the mortgages have to bear risk for the marges they issue. then somebody -- somebody is penalized, either through the down payment requirement or the interest cost or the bank that has the reserve capital against the mortgage.
somebody along the supply chain is penalized appropriately there isn't the mortgage risk subsidization coming from the taxpayer. so if we have decided as a society that the taxpayer is going to subsidize mortgage risk that means both things like the g.s.e.'s are going to happen but it also means prudential regulation is going to be inadequate. i think it's powerful to think about things that way. then you can explain two things that seem like they might be separate causes as really the same -- two man testations of the same decision politically. so i also want to emphasize what the role of -- how complex this is and difficult. for example, you heard earlier aaron talking about how can the c.r.a. be part of the cause of the crisis when the c.r.a. was so harmless for two decades almost? and the answer is, that the c.r.a. actually was important in the crisis. in my book, "fragile by design" with steve haber, we talked about this. the reason is there was an
interactive effect between the c.r.a. and g.s.e. you start looking, when does the c.r.a. start leading banks to make major concessions to urban activist groups in terms of contracts? when does that happen? basically it takes off after 1992. so there actually is a connection between the c.r.a. mandates and the g.s.e. mandates. i'm not going to go into all this but you're free to go take a look at my bank, "fragile by design" that explains this. there are a lot of puzzles though. it's not so obvious when you're looking at this, causeation requires thinking and sometimes fairly deep thinking. so on the regulatory side i don't think it's so difficult to understand fore bearance by regulators given the political impetus of the mortgage subsidy movement. i do want to emphasize a couple of things that i think are confusing people. one is why did things accelerate so much on the g.s.e. side in 2004.
well, i can tell you why, because i testified about this before congress in december, 2009. i was privy to the emails of the freddie mac management. and the answer is because they ran up against constraint. they couldn't expand their lending fast enough to meet their mandates if they didn't completely abolish their ceiling for undocumented mortgages. and the risk managers of freddie mac complained to the management and said we know from the past that if we d this there's going to be a major cost, it's going to be borne by mortgage holders themselves, as well as by our stockholders. it's not good for the country. it's not good for us, it's not good for the borrowers. that person was fired and now i think probably still teaches junior high school math instead of being a risk manager at freddie mac. and this was true, there was a complete steam rolling and there was an acceleration. 2004 was a key turning point. now another thing that you'll
see often is people who don't believe the g.s.e.'s were important will say is, well the g.s.e.'s had mandates for low income and inner city housing but the mortgage crisis went way beyond that. well that's true. but the g.s.e.'s couldn't do something they couldn't selectively relax their no docs mortgage limits. they couldn't. because they wanted to pretend they weren't taking risks. so they couldn't say, we're going to relax no docs limits for risky inner city borrowers so they had to say we're going to relax no docs limits because they aren't risky and therefore we're doing it across the board. a key part of the sublety of causality analysis. i think is very essential. that if you just look at it from that standpoint, was it only inner city and low income people who had mortgage risk? no. why didn't the g.s.e.'s only relax tan stards -- standards
for them? they couldn't. they would have if they could have. another question i was asking of steve in his presentation, why were the models so bad and why did buy side investors and insurance companies who were insures this -- insuring this risk participate in it? i don't have all the answers for that but i'm going to give you two ideas for an answer. one of them is, if you want private mortgage insurance, instead of relying on a paper, you knew exactly what the risks were and pretended you didn't. look at his paper. there's no question the private mortgage insurers understood they were taking much more risk than they were being rewarded for on the margin. why did they do it? because fannie mae told them you were either all in or you were all out. they had a choice. they either had to play along with believing, predending -- pretend they believed the model or they had to exit the business.
maybe they should have decided to exit the business. but they didn't. so it's way to understand the causality of the actual negotiations that are going on that you can see the full dimensionality of the g.s.e.'s role. and there's a pinal one. -- a final one. why would anybody participate in private market holding of these mortgages given how risky they were and as i would say, knowing you didn't know how big the risk was that the g.s.e.'s already taken because they lied about it in their accounting. why does that matter? 's very simple, the g.s.e.'s were putting in a put option. a lot of those things privately originated had the option to ell to the g.s.e.'s. everyone had every reason to believe as of 2007, the total
amount of involvement in the market was small enough that the put option was quite good. what was the problem? the g.s.e. accounting was fraudulent. they settled with the s.e.c. on a case basically admitting the fraudulent accounting. a very important point to recognize. and pinto was one of the first and peter and i followed the lead and got to know ed who said there is a lot of fraudulent accounting going on. this was very important. we shouldn't forget how much we didn't know in 2007 about the aggregate size. that would explain why you were a holder, you were still willing to hold it because there was an entity of a growing mandate of its mandate. every reason to believe you could dump it. the puzzles we have about the
private mortgage issuers are largely, not entirely perhaps, but largely ex applicable how they were playing the game on multiple dimensions. now i want to come to the second part. i think there is no question that the cause atlanta was there but why wasn't there the egulateors didn't intervene? >> when it says january 2009 that is september, 2008, because it is a 90-backward looking
average. look in the olive green in april of 2006 which was three months earlier, 13% market value of equity relative to market value of assets. that's a very high capital ra slow. notice by the summer of 2008, it is down below 3%. this is a steady decline. these are all the u.s. institutions. with the market close to these institutions know, they were raising them and the unions were raising $500 billion of new capital. the market was open. they could have raised a lot more. could they have in march or april of 2008 restored their capital up to a 10% level? yes, they could have? why didn't they? they had the back stop. so the regulateors did two
things from march to september, it was six months and first bailed out share holders at $10 a share for equity holders. and the second thing they did was not react to this. not react to the market telling them that equity was getting dangerously low. what was lay man's fail insure it was a match in a tinder box. these banks were viewed as approaching and exceeding in 2008 the insolvency point. the market viewed them as insole vept by august, september, 2008, and that didn't have to be the case. n had failed, that wouldn't have be a systemic crisis. it was a regulatory failure and lack of response to the market signals that the regulateors did quite intentionally and
knowingly and we don't hold them accountable. capital?citibank's it was almost 12%. what was its market value, under 2%, which is insolvent. so i have already talked about these things. why didn't we do it? part of the story is we didn't understand the severity of the shock. and the reason for that is that fannie and freddie were lying about the size of the shock. i want you to remember, the i.m.f. were providing independent measurement of what they saw the size of the shock was. it went to $2 trillion over not a long period of time. that really reflected the fraud that was accounting at the g.s.e.'s because they were being used as a metric for a lot of things. i want to go on to talk about
the false narrative of the crisis and why it's been created critically. and part of the reason, avoiding recognition of the problem, it allows us to keep on doing the same thing. and jeb hensarling are right that systemic risk and steve is right and the indexes that systemic risk is rising. that is predictable. the same coalition, the same political coalition that gave us the crisis gave us the regulation that was supposed to fix the crisis. barney frank said the only attempt to reign in the mortgage risk which were the standards, they were less to regulateors than explicitly stated as leverage amounts or debt-to-income limits so congress didn't have to do the hard thing and left to the fed. and it does a scraping to look
t whoa lobbies them. and the housing industry. used to have the big banks in it. but they were only in it when they needed to do mergers. that's the story in my book but they dropped out of the coalition. the big banks were not part of the political coalition in favor of subsidizing mortgage risk after the crisis, but they were in favor of it prior to the crisis. but the important part is, these are pretty influential lobbyists and what occurred it down. they made the same thing. and they used the weakened standard. that is all predictable. even more predictable is what barney frank called the loophole that ate the standard. if the g.s.e.'s or buying your mortgage then the standards don't have to apply.
wait a minute, i might predict would happen. maybe the g.s.e.'s will absorb the market and put them under the stewardship of mr. watt who will lower down payment requirements from 5% to 3% and do everything to subsidize mortgage risk along the way. so not surprising we now have mortgage markets that is taken over. wasn't that predictable when we created the loophole that will created the standard. that's the same frank in dodd-frank. so what are we doing? that should be our question, politically what are we doing as a society. when i go up to testify which i have done many times, i get it from both sides of the aisle when i talk about this. haven't i heard of the american dream, they ask? ok, so.
i want to point out a few things. i did some research if presidential candidates rewarded for creating big mortgage subsidies. they are penalized for taking them away but not rewarded for creating them. that means it is the smoke-filled room that is giving us the mortgage subsidy. i want to point out this is an international problem and in a paper that of the i.m.f. and i put out in the working paper, what's really driven a lot of the expansion in internationally, the zizzation of mortgage risk is the protection of banks. governments protect banks by offering deposit insurance and they can twist the arms of the bank to expand mortgages or they can take away the liquidy risk which makes the banks -- so
mortgage rimbing is associated with the other gorilla of the two gorillas in the room which is protection of banks. these are political problems that we follower ate. what to do. when i see a problem that i can't fix, i try to think, well is there a -- is there an alternative that might work politically? and here's what i would say. instead of having dealing with poverty, you are going to excuse at justifies this huge expenditure. the pros that we took seriously, the idea of means tested downpayment matching payments by the government for poor people. opposite of subsidizing leverage but subsidizes downpayments and has the less effect on house
prices or reduces house leverage. i think the real question politically is where can we find a leader who would be willing to say this is a political problem. only way we are going to replace it with the zizzation of leverage or downpayments. and then i think we might make some progress. thank you. > thank you very much. we have dime for questions for charles and anyone on the panel want to raise an issue of the kind that charles just talked about? >> you made the point about the low doc, no-doc. they bemoaned the fact they were introducing low payment loans but couldn't keep them from spreading to the rest of the market and was costing them
money because they were subsidizing these things. but that was known about for 70 years. i disagree a bit with your bservation about low doc, no doc. we need to make it available to everyone so it won't look like it is subsidized. if they wanted to, they couldn't keep it from spreading. >> here's what i'm saying. there is a study issued by a couple of researchers that have influence right now that says it can't be that affordable housing policy caused the crisis. why? because not only lower income people increased their mortgage risk. what i'm saying is, the relaxation of the g.s.e.'s applied across the board. they didn't do it selectively.
so therefore, the question is from a cowsal standpoint, why did they do it? we can read their emails. the reason they did it is to achieve their affordable housing goals. you won't be able to tell whether affordable housing policy caused the cries is to see if the risk was greater in the affordable housing niche. that's my point. we gee. but i want to emphasize, someone sent me an email that the argument that i just gave you is why there is not consensus at our u.s. treasury that affordable housing policy was a major contributor to the crisis because the crisis wasn't just happening in affordable housing. that is a childish view of causality. you need to understand why it happened. >> questions from the floor.
yes, sir. >> i'm from karr capital. and great presentation, charlie. the one thing i'm mystified is why monetary policy isn't the ultimate cause. money is like water and flows through the path of least resistance which we heard was the housing market 10 years ago and 20 years before that, it was commercial real estate and before that, it was petro dollars to developing countries. >> and before that i was commercial real estate. >> you mentioned 2004 is where fannie started going crazy, but 2003 is where the fed balance sheet started going crazy. and dropped by 35%. why isn't monetary policy the
ultimate factor? >> i didn't say it wasn't an important factor and i agreed with bill pool's discussion. if you ask the question would the same monetary policy absent any affordable housing policy cause anything like we experienced? i think the answer is no. it was definitely important. let's look at europe. if you look at europe during much of the same period, the two policies are linked so it is loose there, too. but ireland and spain that have housing bubbles twice the size of ours. why is it happening in ireland and spain rather than throughout europe? they are dealing with the same monetary policy. particularly in the case of spain, that is understandable as something quite akin to affordable housing policy. in ireland it's more complicated.
industries. t's an aggregate instrument. >> charlie, you mentioned just briefly about downpayment subsidies. and i know they have been proposed in other contexts but seems to be a serious political problem there in there you would have a fiscal cost with it and i would ask you where is the political consensus that lower income, less wealthy people should be gifted money to go out and buy a house? >> it's not an easy win. let me explain. you have given part of the explanation not an easy win. however it's matching and it is rewarding thrift of low-income people which is something i
could sell, maybe not sell to everyone but a large group of the population. there is a bigger hurdle than the one you are mentioning, we would cost the poverty intermediaries would be pushed aside. the reason they love mortgage risk zizzation they get to take a fee out of this where this gets the middle man out of the way. that observation might be a way to get some people on the republican side of the aisle to like the idea. >> but there is a more basic issue there and that is ownership versus renting. should a lot of people of very modest means have a lot of their wealth tied up in housing given the volatility of housing prices? i think that's not in the discussion enough today and that s renting versus owning. modest incomes would be better off renting rather than owning. >> i don't say here, i'm
completely in favor of some equivalent rent subsidy program that would apply to low-income people, too. i guess here's my point. you have to take the politics of this seriously and start thinking about which policy you prefer. and that's not been in our conversation. >> you'll have a chance to intervene later. >> i think you have said it all. twice. our next panelist is alex pollock, originator of -- [laughter] >> alex he is a distinguished ellow in washington. previously, he was resident fellow at the american and much missed resident fellow at the american enterprise institute
from 2004-2015. he was president and chief executive officer of the federal home loan bank in chicago. and he is the author of a book "finance and philosophy." there will be a conference on finance and philosophy on october 18 for all of you who want to put that down in your blackberries and director of the c.m.e. group, great lakes higher education corporation and great books foundation. alex, you have 20 minutes. >> thank you for the advertisement for the book and putting me on this panel with so many distinguished colleagues. i'm shocked that charlie thinks this is all political. he also points out this is an international problem. so i would like to start off by saying in addition to the 10th anniversary we have all been
discussing today is an important 11th anniversary. northern er 14, 2007, rock bank, a major british mortgage lender was in distress and there was an announcement about an emergency plan and that day long line of depositors began to form outside the branches of norninge rock. website collapsed i'm told and phone lines were jammed. that's the day queen victoria was under way and first bailout of the 2007-2009 financial crisis which reached its peak panic one year later. let me review some of the events that the panic approach as background. in june, 2008, larry lindsay
wrote an article entitled, it's only going to get worse. he was so right. in july, congress passed a law authorizing the treasury to put money into fannie and freddie and secretary paulsen said he wouldn't have to do it. but nervous calls from officials in foreign countries to the u.s. treasury were insistently urging that their large investments in the securities of fannie and freddie had to be protected by the u.s. government. on september 7, week before the events we are talking about, fannie and freddie were put into conservatorship. and the stock closed at $7 a share. on monday, it was 73 cents. a week later, friday september closed at stock
$3.65, following monday, 21 cents. bush submitted the tarp plan to congress. phil who was there in the treasury knows full well. secretary paulsen later wrote, we had no choice but to fly by the seat of our pants making it up as we went along. i think that was a fair description. now imagine your secretary of treasury, you were in the fog of crisis but you can see you and your colleagues are standing on the edge of a cliff, you think that's likely, staring at the abyss of a possible debt deflation. i have total sympathy of these officers. don't you? in their place would you choose
to risk of being one who did nothing in the crisis? of course not. you will intervene and keep intervening with whatever bailouts seem necessary. your only objective will be to survive the crisis and that's what you would do if you were in office and so as anybody else. i have to fully agree that the emergency actions used the last time ought to be available to the responsible officers. n 2008, they didn't bail out lehman. would you have bailed out them out? as has been pointed out, the panic this intense climb action was the result of more than of a decade of a long buildup of leverage and risk. you have to go back to the
1990's to understand what was going on. this growing risk as has been rightly said was promoted by the u.s. government. increased in risks seem at the time? the central bankers believed they had created the great moderation, as they called it. it turned out to be the great leveraging. tim geithner president of the federal reserve bank in new york thought in 2006 that financial institutions are able to manage risk more effectively. believe was common at the time. but as a quote, the reality is we didn't understand the economy well as we thought we did said don cohen. he later squeaks in a lot of other people who didn't
understand it either. does the fed understand the economy today do you think it did than in the early 2000's. does it understand the risk any better. does the fed, candid about the uncertainty it always faces or bill pool called the uncertainty real-time a.m. big youity. he government promoted debt. the national home ownership strategy of the clinton administration pushed for innovative, that is to say bad credit quality in mortgage loans. we have often said and it goes without saying the government promoted excess debt and house iing leverage to fannie and freddie and continues to do so today and these have never been rejected by the government, which has carried them out.
aaron kline said that s.i.d.'s are dangerous but fannie and freddie and get financing off balance sheet and off the books and risk along with it. the crisis ended in the spring of 2009 after the fed had the very good sense to replace with stress tests which was a way of the problem. whether by cause or so insidens. the stock marketed started up. the s&p index which had been 281 on september 12, 2008, bottomed at 77 in march, 2009, a loss of more than 70%. since then it is back up over 500. the boom seems like it will last
forever. and it seems that the bust will last forever. that's how it feels to virtually everybody while it's happening. by mid-year 2009, it was clear it survived the crisis and now for the political reaction as happens in every financial cycle. now is the hour for the politicians including those who made such things worse to show how they would fix the problem. as charlie said, banking and finance generally entails political deals and here we were again. some of us, including peter, ed, chairman hensarling and me thought it was a great opportunity to restructure the u.s. housing finance system into a primarily private market system with private capital bearing the risk of whatever
actions it decided to take. in 2010, i proposed in a piece called "after the bubble" to create ar private secondary market, design a transition to having no government sponsored enterprises, stop using the banking system to double leverage the g.s.e.'s should they survive. facilitate credit risk by mortgage originators which is where it really belongs. develop discipline. and loan reserves in good times. use a short key mortgage information form for borrowers to focus on whether they can afford the loan. address the banking systems huge overconcentration in real estate risk and rediscover savings as an explicit goal. that seems like a pretty good list to me, but needless to say
it was not the direction taken. a different path was chosen, one always available to the legislation to expand regulations with orders they are not to let this happen again. this was in spite of the fact that no regulator had the foresight to predict the financial crisis and we all know that is true. they may have seen different problems but nobody predicted the crisis and its depth and severity. the most interesting question is hy did the regulateors fail to foresee the crisis? it was not because they were not trying. as chairman hensarling said at lunch, they were busy and diligently regulating away the whole time, as hard as they could. short coming perhaps is
hindsight but perhaps they were not trying and also not because they were not intelligent. the problem is and always is one of knowledge of the future. not a problem of effort. the problem is inherent uncertainty and lack of knowledge of the future. the mismatch between prevailing ideas and the emergent surprising reality. there is another problem. the regulateors by definition are employees of the government. they can't be expected to stop activities the government is intent on promoting or act against the interests of their employers, in other words. as bill pool so convincingly discussed earlier and wrote in his paper for this conference, an obvious first observation is that the affordable housing policy and mortgage goal given from members of
the congress, president clinton and president bush. should the fed have undercut the stated policies of the president and the congress? the same question applies to every regulatory agency to every part of the government. in spite of these problems, the politicians did what they do, which is expand the regulatory bureaucracies and give them more power renewing wilson's faith in so-called expert bureaucracy. new rules protect the politician who had to do something so that he can't be charged with not doing anything or not doing enough. there's no doubt in my mind that the thousands of man years that went into negotiating and writing all the new rules were spent largely by intelligent, informed, well intentioned
people intent on making the financial system into a mechanism with less chance of failure. we know that the chance of failure never becomes zero. this is a fine goal, but it suffers from the fact that financial markets are not a members of the committeism. they are amergsnt interactive set of interactions.
this case, the committee was financial stability oversight council and was trying to avoid systemic risk. there is no evidence they have the ability to do this, but creating was a sensible action. no one could accuse them of ignoring systemic risk. it was given the power and important for siffeys. t it has utterly failed to designate the most blatantly obvious. freddiee fannie mae and
mack. they have not admitted let alone acted on the fact clear to everybody in the world that fannie and freddie are important and generate systemic risk. now this may be politically prudent on their part but intellectually vack youous. fannie and freddie should be designated that they are because etter late than never. it cannot control or even point out the systemic risk created by the government itself. that criticized their employer and we know a lot of systemic risk is created by the government. last point i'll make is a key one. the post-crisis political reaction insisted there had to be more equity capital in the
financial system. this was a good idea. but note, the bank's capital was able to get so small in the first place only because the government was creggetly believed to be guaranteed. fannie and freddie's capital was able to get small only because of the correct belief that the government was guaranteeing their creditors. how did we get there? the wake of the bust, the federal reserve sent out to create a wealth effect by pushing back up the price of houses and the prices of financial assets in order in theory to stimulate economic growth. as we all know, it pursued this by massive purchases of long-term bonds and mortgages
swelling its balance sheet up to $4.5 trillion and kept real term interest rates negative for almost seven years which is an extraordinary fact. whatever the arguments could be and i think there are some good ones for doing such things as short-term crisis measures, the fed has kept them as a long-term unquestionably in my mind diss forgsary programs only now reducing its balance sheet slightly and getting short-term interest rates only up to approximately zero. the result has been a massive inflation in real estate, financial assets and other assets including a renewed house boom as has been pointed out over house prices are well thrir bubble peek.
there were excess reserves. i consider this to be a really clever strategy by the fed. this allowed it to suppress the bank credit expansion which would have occurred in the private banks at least according to classic banking theory if they had to hold noninterest bearing reserves. instead of that, deposits were held with the fed allowing it to allocate credit itself instead. what did it allocate credit over these last eight to 10 years? through housing and through the government deficit. well, where and how the fed induced pricing, inflation will end, i don't know. and the fed doesn't know. and the financial regulateors don't know. and neither does anyone else.
that is hidden in the uncertainty of the economic future. it may be we will get the feds for a soft landing. finally, here is a reminder of some essential things not done by politicians or the regulateors or central bank in the wake of the crisis. they did not create a private secondary market for prime mortgages. they did not design the transition to having no g.s.e.'s. they have not developed countercyclical loan to value and did not value the real estate risk. they did not rediscover savings as an explicit goal of housing finance. they did get equity ratios increased. and did preside over a giant
asset price inflation. what next? well, this period we're in is a period of uncertainty, just like every other period. thank you. >> do we have any questions on the panel? alex, i want to raise a question with you, actually, and that is you have not shown a great deal of respect for the fed. [laughter] >> something that speaks wisdom on your part. but then, you want to have fannie and freddie which would on turn them over to the control f the fed. how is that consistent? >> absolutely sensible. you want somebody who isn't a cheerleader. long ago there used to be
something that some of us may remember the federal home loan bank board, the federal home loan bank board was abolished and succeeded by the federal housing finance board which was abolished and succeeded by the federal finance agency. .'m sorry all of these structures have the problem that in addition trying to control risk, they're cheerleaders for housing finance. we see this very clearly in the policies under mr. watt. we want and we need to have somebody focusing on them and hearing about their risk who is not a cheerleader for housing
and i think the fed for all its faults is not a cheerleader for housing. >> cheerleader for that fed. >> the fed is full of truly competent, smart, diligent people like steve was. so it problem isn't the people or the institution. the problem is the fundamental nature of financial market and the unnobleness of the financial future. >> didn't you say the fed was part of the federal government and wouldn't go against their bosses. why would they regulate fannie and freddie?
the economists had the first clear understanding of the instability of a fractional reserve banking system. so a bank gives a depositor at redeem e a promise to the deposit in gold. and there were more promises outstanding than there was gold. and so when there was a banking crisis, which occurred from time to time in the 19th century and again in the 1930's, there was a flight to gold and no way to increase the quantity of gold. the thing that was fundamental about the most recent financial crisis was that there was a very similar flight to what i call good money. ood money was a claim on the u.s. government. and so people fleing the
uncertainty of the -- i call it private money in many markets wanted good money and the good money was a claim on the federal government. now, the only way, the only way that you could reach stability in that situation was to have a arge increase in good money. and the only entity that could increase good money was the federal reserve. so if you think back to the depold standard, the gold standard could have been stable if there was a way to have a vast increase in the quantity of gold at the time of a crisis, but that was impossible i believe. but in the case of a financial disturbance, the federal reserve, central bank could increase indefinitely really the claims on the u.s. government.
now the problem is to keep that separate from the idea of a bailout. bail out and institution. the approach was to say lend freely at a penalty rate. and so lending freely meant that you could have an expansion of the claim on the bank of england and that could handle the crisis. and it incentive not to take it too far or not to be a bailout was to have the lending at a penalty rate. part of the discussion is the failure to understand is what the crisis was really about was the flight to good money. >> i agree with everything that you just said. and the way i described that flight, i call it the two big
balance sheets. if the aggregate balance sheet of all private entities is trying to shrink, ask yourself how could everyone shrink at once. if everyone tries to shrink at once, how could that happen? you have to have another balance sheet. that's another way to say what you just said. i do support the idea of keeping these emergency powers on the shelf. the next time we're surprised because crises by definition are unexpected. so we are always surprised when they happen and then we get these fire drills along with the fire sale. but that's why i think it's important in reading the history
post bubble to say there were short-term things to be done but there are things going on for seven, eight, 10 years. hat's a different issue. >> you talked about designation a important financial institution. i think we have all heard in this room, designation and systemic nature is not about five, and the very next word, every time it's interconnected. there are a list of others. [indiscernible] >> there is nothing more interconnected than the federal home loan bank system. this is by law. there is joint and several liability of the entire financial system which would be illegal and doesn't exist
nowhere else than in the home loan system. if you go back to the system and map a slide but if you where folks were running to get funding in 2007 with the worst lenders, list of folks that were the deepest in toxic loans, it why the up explains fed didn't see where the stuff was coming as the music was stopping. given all of that, do you support designation of the home loan bank system? >> i was hoping you were going to start off saying how much you like my line about freddie and fannie. i don't think anybody is more interconnected than fannie and fred quee and the home loan banks is very true as people
were running for good money in the market, debt issuances by home loan banks were that kind of good money. and the reason the home loan banks could expand their loans to say countrywide is because the buyers of short-term debt would buy home loan as good money in bill's terms. so you make a strong argument, you want fannie and freddie and throw in the home loan banks. and i say that are inspite of being a member of the alumni club. >> i have to defend what scott has said because he is not here to talk about it, but i think he showed that interconnecttiveness had nothing to did with the inancial cries is but what was contageion all of these institutions holding all of the same bad assets. i don't think you guys are
actually on the same wave length. but we should pass onto the next who is phil swagel. he is a professor of the university of maryland's school of public policy and teaches courses on economic policy and nonresident fellow here at the american interprice institute. he was the assistant secretary for economic policy at the treasure difficult department during the financial crisis serving from december, fwicks, to january, 2009. he received his bachelor's degree in economics at princeton harvardand his phd from in 1993. >> thank you very much. it's a pleasure to be here. i'm going to focus on the policy response.
my role at the treasury as assistant secretary of economic policy. and i did a lot of work on housing policy and lot of work on the tarp. and the pre-occursors to the tarp as well. there is eaning excellent team at treasury and it was an honor and privilege to work with them at the treasury and this continued over across the administration. there is a lot of continuity in many things across the two administrations including the excellence of the teams working on it. i have a recent paper from a conference at brookings over the last couple of days evaluating the outcomes of the financial crisis and the historical evidence. if you are interested in more on this, i would suggest going to that -- going there and finding that paper. oined with milley lang and meg
mcconnell. i recently testified on g.s.e.'s so i have recent testimony on the house financial services committee on g.s.e.'s as well. i'll talk about the policy response rather than the causes of the cries is which we heard a lot about. and there is a lot of economic research since the crisis looking at it and my evaluation that research that have identified the key causal role in the crisis in the expansion of lending that was tied to expansion of lending and origination and securitization and misconduct. in the origination model, they are very, very closely related.
and expansion of leapeding started in subprime and then ought in beyond that the mortgages where positively larger in dollar terms and subprime but pretty convincing evidence that the problem started in subprime and expanded out. leading to the bubble, collapse of the bubble, recession and crisis. the policy response and the way i think about it is in three phases. and again, this is very much mirroring the paper that i put out with two co-authors. from august, 2007 until just before bear stearns and collapse and rescue of bear stearns. the policies there were from the fed on fiscal stimulus enacted
in january of 2008 and economic research that evaluates these policies. e t.a.f. extending the discount window both of the institutions to avoid the borrowing and providing term funding rather than overnight funding and large literature looking at that, the t.a.f. was successive of reducing strains in the interbanking market. literature as well looking at the fiscal stimulus enacted in january of 2008. the checks started going out in april and paper in may. there is about $100 billion injected into the economy roughly in the middle of the but that quaint now, was $100 million in stimulus was
a large amount. i can remember the staff, the excellent staff at the treasury who handled the mechanics of bond sales and worried about being able to fund so quickly not not ow now that is what it used to be or something. stimulus, in the end, research by jonathan parker at m.i.t. and others. against the headwinds of the financial strains and high energy prices. some of this didn't stop the recession. the economy is already in recession. we know a very mild recession. g.d.p. growth was positive in 2008. but nonetheless, it was a recession.
and the stimulus helped keep the economy afloat until later in worse r when obviously things happened. something else that i have written about elsewhere is actions at treasury. one of them was treasury officials urging private financial institutions to raise capital. some did and some didn't and some clearly did not raise enough. that's phase one. phase two is starting with the collapse, near collapse at bear stearns and intervention by the fed to assist acquisition of bear stearns by jpmorgan chase and that was the first. first time since the great depression that the fed invoked its emergency powers. this is the primary dealer credit facility opening the discount window to investment
banks. and bear stearns was the bailout. clearly a bailout. bailout of the bond holders or counter parties of bear stearns. my understanding is that bear stearns' management were heavily -- the share holders of the firm relative to other similar firms. and i suspect they didn't feel like they got bailed out at $10. i gather there is a lawyer problem at jpmorgan chase. and secretary paulsen said in his book said it should have been zero but zero through 10, i don't feel like the equity holders felt they were bailed out. ut the bond holders got bailed out. bear stearns was a key counterparty in the three party repo system. they are in the middle.
the p people on the other end might have failed and so they are rescued. the idea that equity holders of the other firm saying we are fine. the fed will bail us out. the bond holders for sure. but the equity holders not so much. so i think the way the markets solved it in march and the bear of beer stearns -- stearns is giving lehman and the other firms to take care of themselves. it was clear, many market participants that other systems had problems and they would fund lehman and give them time to work things out. they were there to help them do it.
and we know in retrospect they didn't. lehman didn't take advantage of that. there is a book "too big to fail," some people will say too big to read. it's one of those books that you can't stop reading. . . there's lots of discussion in this book of what was happening at lehman and back and forth. ok. over the summer, as discussed before, there's legislation enacted, the legislation that later allowed the conservatorship of the g.s.e.'s, independent regulator took fannie and freddie into conservatorship. so my evaluation of that, the conservatorship stabilized the housing finance system. my observation is that mortgage financing was available throughout the crisis even as
there are strains to the other parts of the financial market. that's the sense which i evaluate the conservatorship as a success in responding to the crisis because had the firms had a failed auction or found themselves, you know, on the wrong side of liquidity problem, it would have meant difficulty for americans in the housing sector. anytime the rest of the economy is week there are strains in the financial market. that was in early september. what's interesting, if you look at the c.b.o., the congressional budget office's forecast of the economy in early 2008 -- so this came out a week before lehman's failure. the c.b.o. saw a difficult second half of the year. they saw -- i don't remember if it was zero growth or slightly negative. it was flat. zero growth and then slight
recovery in 2009. it was a week before lehman. it's not like c.b.o. has glasses to see into the future but their forecast is probably as good as anyone's. they didn't see the collapse in the sense that was coming. ok. phase three, of course, lehman and a.i.g. and all the things that took place afterwards. sorry. i just want to check my time here. ok. huge number of policy interventions that happened starting phase three. the tarp, of course. the temporary loan guarantee program from the fdic. quan tative easing. large scale purchases from the federal reserve. the backstop on securitization. there is a guarantee from the treasury department on money market mutual funds. money market fwunding --
funding facility from the fed. i am probably missing some. there are a huge number of interventions. again, my paper that just came out goes through some of these in more detail. and what was striking to me and to my co-authors as we wrote in paper was the economic literature that evalue waits these interventions finds -- evaluates these interventions finds them effective. the telf which went into effect march, 2009. the key staffer -- the godfather of telf, steve, stated the treasury into the geithner treasury and was there to get it launched. evaluation of the telf finds it reduced spreads, reduced interest rates on securitized assets but didn't reduce interest rates on any particular issue within the universe it was covered.
so it sounds pretty good. helped relieve strains in asset-backed securitization without favoring one or the other. now, the program did favor some markets over others because tractor loans were in and some other loans were out. that's precisely the fed allocating credit. as i look at the -- you know, the policy response, it's a murph how concerned chairman bernanke and his colleagues were about the economy that they took these steps. obviously they are not -- they're not in the business, they don't want to be choosing tractor loans over other loans and yet they felt the economy as in such bad shape that that was necessary. the tarp, of course, is the best known in the policy responses. there's an evaluation from 2010
paper that looks at the events of columbus day when the tarp was first used to inject capital into the large banks and finds it was effective. the benefits of the main actions on columbus day, the fdic's loan guarantee program added positive value to the economy. there's a cost to taxpayers of providing this insurance. if i sell you fire insurance at too low a premium and your house doesn't burn down and i don't have to pay out on the fire insurance, of course, there's still a cost, right? so the evaluation of those -- the fdic's loan guarantee, the treasury capital injections found that, you know, quantified the cost to taxpayers and the benefit to the financial system of the improvement in the financial status of the firms receiving funding from the treasury and he guarantee from the fdic and
is a net positive. i say the policies were effective. yes, it's a tragedy they were necessary but they were effective. you know, even the housing programs, which were mainly later, mainly in the obama administration, i was involved in a paper that hasn't come out from the same project at brookings looking at the housing policy response and the interesting is that housing policy response was at a lesser scale than promised. early in the obama administration, i think they understood. they just made a mistake of overpromising. it moved more slowly. harp 2, the refinance program, ed demarco, the f.h.a. director
at the time, was a key person getting that done. eventually the 401-k provential policies were -- the foreclosure prevention policies were effective. not as much and not as soon as was promised. the big picture from my paper, brookings, shows the u.s. recovery while the recession was terrible and the recession and foreclosures were considerable hardship for millions of americans, the u.s. recovery was actually better than would be expected from the historical experience. if you evaluate past crises that involved financial crisis, so past recessions with financial crises on top, the u.s. recovery was faster than would have been expected given the severity of the negative financial shock. so that's -- obviously that's cold comfort to anyone who lost their home but that's the
evaluation. so let me say, where are we we, today the system is much safer. we're in better shape. banks are much better capitalized. at least more than double the capital. the data i have is that risk weighted assets -- capital funding is about 12% of risk-weighted assets at the largest banks. more than double what it was during the crisis. the new authorities, especially title 2 of the dodd-frank act, which allows nonbank resolution authority that wasn't available during the crisis. i suspect it would have been used for either lehman or a.i.g. almost certainly for a.i.g. instead, the fed intervened. i worry about misuse of title 2. it's a topic for another discussion, but even with my concerns about the misuse, i am still glad it's there. and as the other speakers have said, we still have the
g.s.e.'s. there's more private capital at the g.s.e.'s, especially with the risk transfers that have been put in place. but there's still too much taxpayer risk in a sense that's still the unfinished business. why don't i stop there. mr. wallison: ok. comments from the panel? and you may go. charlie. go ahead. charlie: i mean, that was a very rosy picture of government policy from march to september, 2008. and i don't buy it. so let me talk about a much less rosy picture. the question is, was it obvious -- let's say, as of april, may, june, 2008, that there were rious problems that required that the large institutions to raise more capital and were the markets open? the answer is yes to both
questions. how do we know that? lots of ways. i showed market values of equity that were clearly signaling that. i know it for other reasons. met life took a very close look at buying bear stearns. when did they exit from buying from that look? i think it was june. when they exited, who did they talk to and one of the answers? i know one of the members of met life -- mr. wallison: he announced he's stepping down. mr. calomiris: that's not nice. called the new york fed and said the reason we are not buying lehman is because it's very deeply insolvent and you need to get serious about the problems about the mortgage market immediately. that president of the new york fed basically hung up on him nd never did anything.
mr. swagel: is there a question here? mr. calomiris: i have another piece of evidence which is -- mr. swagel: ok. you have to -- i will do eter's job here. mr. wallison: let him talk a little bit. mr. calomiris: why do you let people off the hook from september to may, 2008? mr. swagel: the answer is i can do arithmetic. the -- what was needed? this is a crisis of lack of capital. i agree reentirely. the amount of capital raised was inadequate. firms did raise private capital and the ones that raised private capital tend to do etter.
the arithmetic is that it required public capital in the tarp and the arithmetic i can do is the votes for that were not there. you require we all understand the way the constitution works, especially here at a.e.i., imagine going to the congress and saying, you know, look, things are bad. you know, congress on a bipartisan basis just passed a stimulus package much faster than anyone could ever have imagined and that's now going through the economy. this is march after bear stearns was rescued. the check hadn't gone out yet. congress going to the banking committee, leadership and saying, you know, we don't know what's going to happen. the forecasts are all ok. g.d.p. growth is positive but we need to inject public capital. i would say the arithmetic is that would not have happened. the other arithmetic, our
resolution authority, the fdic has the authority to resolve depository institutions but the problem is that we're talking about are not a depository institutions. they are the broker dealers and investment banks and others and no resolution authority. now, there is today. title 2 of dodd-frank. but, again, the arithmetic i have in mind is the votes to obtain resolution authority were not there. i am being a little flip. i don't do conspiracy theory well. what could regulators have done? the regulators -- i think this might be where charlie and i agree is that dividends. there are lots of people that look toe dividends payment of these firms and said there is a strong case to be made that the supervisor should have basically gone to the institutions and told them, look, you either raise capital or you retain your earnings.
obviously that's a whole other discussion. if you turn off the dividends, it gets hardtory raise capital. other things. the idea that people did miss things -- well, i agree with that very strongly, the idea that, you know, the public policy steps that could have been taken earlier, whether resolution authority or private capital, i think it's difficult to believe. mr. calomiris: private capital to be raised privately mr. swagel: i want to respond. i made friends with a lot of lawyers in 2009. there is a paper i wrote for brookings that said anytime economists use the word "force," the next sentence should explain what part of the u.s. code provides the authority. i think today we understand probably regulators could have said, look, you have to raise capital. mr. wallison: any questions out
here? es, sir. >> pete kyle, university of maryland. i am going to followup on what charlie was talking about. you said the debtholders were bailed out of bear stearns and the equity holders were not. they were facing a pretty dire situation. but doesn't that exactly create zero incentive to raise new capital? you're basically saying the government wasn't going to force them to raise new capital but yet the government instituted a policy that discouraged them from raising capital themselves. you are creating a situation where you knew there was not going to be any capital going into the banking system except modest amounts except maybe after march of 2008 compared to what was needed. mr. swagel: what pete is pointing out is the well-known debt over -- this is a
situation you don't want to get into. and the question is, once -- in march, 2008, what role does the government have in going to an institution and saying, you are required to raise capital? so, for example, lehman is the best example and i should say as economist at the treasury, i was not involved in these transactions. i wasn't in new york interacting about lehman and all this. my observations are, obviously i was at treasury but somewhat -- at a standoff, if that makes sense. the treasury doesn't regulate lehman. the fed doesn't regulate lehman. the s.e.c. does. is a problem in the -- whether the s.e.c. has any authority at all over capital standards? >> or broker dealers. mr. swagel: it's clearly a gap
in the credit system who are saying, you are forced to raise capital, it's a gap in the -- >> will the me follow up on pete kyle's question because the bailout of bear stearns really sent a message that to the management of all these firms that they didn't have to go into the market and dilute their shareholders, the market was tanked. they'd have to dilute their shareholders in order to keep their creditors confident because the creditors thought after the bailout of bear stearns that they would be bailed out and they didn't have to move. mr. wallison: if the firm failed, they would be covered. and therefore, the managements had no incentive to go out into the market and raise additional capital. so that strikes me as one of the worst mistakes we've ever made in bailing out a
noncommercial bank that had no claim on the government whatsoever. but it created an idea in the market that the government was ing to save all of the other investment banks. and other kinds of institutions that were not previously commercial banks. so how -- if you could answer this question -- what was in the mind of hank paulson when he decided he wanted to bail out bear stearns? what was he afraid of? mr. swagel: ok. so, again, i'll just reiterate, again, if you look at the share price of bear stearns, i think the idea the shareholders of other firms wanted that experience. i think that's not likely. on the other hand, what you said about ensuring the
creditors they could continue to be on the other end of repo transactions from the other firms, to me, peter, you really hit it on the head. that's the key issue. i think there's a debate about bear stearns. i think i answered a lot of things. i think bear stearns is a tough one. i can't tell you. i wasn't involved. i read hank's book. i encourage everyone to read it. it's a really good book. it's really well done. bernanke, geithner, they've a all written books and you can read them all. bear stearns was part of the triparty repo system. the fed has done a lot of work in addressing the work in the triparty repo system. the intraday extensions of credit that were essentially like naked extensions of party. as the triparty repo system
failed there would have been a disaster. and so that, in these books, that's what's identified. it's a gap. there are all these gaps exposed by the crisis, right? the children's hospital of pittsburgh funded themselves by auctioning debt every seven days on a different rate. crazy things. today we understand this duration arbitrage doesn't -- isn't a very stable way to run a hospital. that's, of course, highlighting the problems of the financial system. so that's really it. they are a key part of this important funding mechanism, not just for themselves but other parts of the financial system. again, in much better shape today. but that was the judgment if bear stearns collapsed suddenly that would cause a considerable burden to the financial system. mr. wallison: ok. mr. garrity was in the geithner
treasury right after phil was in the paulson treasury. so let me tell you a little bit about him and then we'll hear from him. he's partner right now at q.u.e. investors based in alexandria. in 2009 to 2016, he held a number of different offices in the treasury department. finishing as the president's nominee and as acting assistant secretary for financial institutions. in that role he was one of the lead advisors to the secretary on policies affecting financial institutions. we're delighted to have you here and we look forward to what you have to say. >> thank you. so really pleased to be here and to participate in this. amias: i will play the role of skunk in a garden party. i want to talk about stories in the crisis. i want to harp on something, alex, you said, the financial
system is an emergeant system. maybe worth calling out for those in the audience who don't follow complex systems theory or sort of advanced mathematics, complex emergence systems, as alex is referring to, is a well-studied field in mathematics, computer science. they have very interesting properties. there's been a lot of academic research in that area. there is a very persuasive case that alex is alluding to that the financial system is a complex system, adaptive system. you can have these systems in nature. you can have these systems even with mechanistic rules but in the financial system we have the added complexity that humans are participating and humans themselves are complex and adaptive systems. they're very good at responding to the rules of the game and to change their behavior. the major point i want to make as we talk about stories of the crisis is to make the point in
much of the conversation we've talked about how did we get a large runup in both the volume and the price in housing assets? but what we have not talked about is how did we get a very large structural change in the financial system, which unraveled in the course of a deleveraging cycle in the fall of 2008 and through the early spring of sprine? -- 2009? let me tell one incomplete story. i was at a cocktail party in -- with a college friend of mine. probably cirque april, 2009. my father friend was there -- my friend's father, i should say, was there. he's a large industrial manufacturer, very successful businessman and he said, you know the real reason we had this crisis is because the i banked i.p.o.'d in 1998 and 1999. i was interested in this theory. and it's actually not an
unpersuasive story, right? because the investment banks did all i.p.o. in 1997, 1998, 1999. they made their partners fantastically wealthy. immediately thereafter they had very large amounts of capital which allowed them to vastly expand their balance sheets. they also had different incentives from a trading culture perspective. larger balance sheets allowed them to do much more frequent, much more significant transactions in the financial markets at a much higher speed. it's worth noting, they allowed them to fund much cheaper on secondary markets on much shorter terms. so in 2008, we have a run on the shadow banking system. you can talk about the precipitating events there, but you have a relatively persuasive story of the crisis from one business decision by a small number of firms in the late 1990's. now, i'm not trying to argue
that's what happened. because there's a number of things that has to happen, to charles' point about deep stories, in order for the story about the investment banks to make sense. well, one, you need to believe in market discipline. i know a lot of people in this firm -- in this room do. i count myself among them, but i think the degree of belief in market discipline took hold in the policy apparatus in the united states government starting in the 1970's in a way we have still yet to significantly examine. and what that allowed us is to believe in a regulatory approach in which disclosure rather than capital was more important. you know, the other thing you need to believe, you need to believe in financial innovation. so you need to believe that derivatives are actually effective in spreading risk. this is another belief which i actually find myself as a venture capitalist -- i spend a lot of time talking about financial innovation. it's not like there's nothing to believe in here.
another thing that's interesting, this is more technical, but var models begin to dominate in the risk management culture. there is a rise in risk management as a quantitative discipline. within that there is a rise in v.a.r. model. value at risk models, as others on the panel have pointed out, value at risk models have a special property, as volatility goes down, risk goes down so they can create volatility paradox which many have come to appreciate even more significantly in the postcrisis environment. you have stories about executive compensation, rewards for risk taking. all these stories are necessary in order to make the investment banking story even partially true. another thing that's necessary, the series of statutory actions. you need a series of inaction or action in the regulatory apparatus. you need the ability of gramm-leach-bliley to come into play. you need regulatory certainty to take derivatives out of the
futures regime. you need bankruptcy reform for derivatives and other financial contracts in order for the explosion in the -- especially in the 2005 to 2008 period. you need the capital standards to be outdated. basel 2 often now recognizes based on the incorrect belief that banks are actually good at modeling their risks but nonetheless has some advantages in terms of the quantifications over basel 1. you need the fact there is no safety and soundness oversight for investment banks and apologize to the s.e.c. that consol dated supervisory. and what phil was talking about, although it was effective was too weak. and in order to have those things you need a bunch of other stories about macroeconomics. you need the great moderation. you need too low for too long. you need reach for yield. and you needed the leveraging cycle. that's just one incomplete
story what happened in the financial crisis. that's not the half of it. that's not even close. this is a map of the shadow banking system written in 2009 and 2010. so here's a lesson from my marriage. i got three small children. often things go wrong in our household and i find myself saying this phrase a lot. "for anything to go wrong, many things need to go wrong." so let's just talk about what did happen. what did we learn in the crisis? what were the faults in the system? because it's important to think about the fallingts in the system, not just from the perspective of deep causes, which i think suggest an ability to root out and to surgical cut out -- surgically cut out the cause of the crisis and to think about financial regulation as a way of protecting against those faults rather than as a surgery to remove some of the deep causes.
so i think we can probably agree on these five points. there was simply not enough capital to absorb losses. the largest most complex financial institutions either failed or teetered near failure. no arrests of the fire -- especially focusing on nonbankette is. there was lack of transparency, collaborate, or capital standards for derivatives. and a fallout of abusive lending practices. and they were largely unchecked by federal bank regulators or state supervisors. this is focused on these faults. the capital we earlier talked about balance sheet repair. this is not just about basel standards. it's also about accounting standards. on the balance sheet to support the activity of banks and other financial institutions through the cycle. a set of reforms -- i know alex and others have been very critical about the financial
stability oversight council and its designations or nondesignations. i don't know if we could have thread that needle, according to alex, but we tried our best. the principle here is straightforward. the highest standards must be apply to the most largest and complex firms, regardless of corporate form. i want to emphasize this -- regardless of corporate form. because the problem with that, as phil alluded to, it's not that the standards were not applied. they were applied inconsistency based on the corporate choices made by large firms. it's important that any firm be allowed to fail. and for any firm to be allowed to fail, you need to have a structure that you can believe in. there's a lot of doubt about title 2. i spend a lot of time working to make it better. i still believe it's the best system that people have come up with, and i don't believe bankruptcy will work. bankruptcy alone does not allow for planning and does not allow for liquidity and you need both of those things to resolve large complex financial institutions. you need comprehensive oversight regimes for
derivatives and securitization. and you need to protect consumers. these were the fundamental pieces of dodd-frank. i can understand it was a long bill for people. i negotiated the whole thing. i understand that. but these five pieces are very straightforwardly embedded there and they are the hearts of the bill. and they worked. bank balance sheets are stronger. derivatives markets are smaller and more standardized. household debt service is better than it's ever been in decades. now, there's a lot going on in each of these charts. certainly lick bidity perspective on -- liquidity perspective on banks. balance sheets have been stronger than ever it's ever been. there are core principles that i think are quite at debate here and i want to articulate them so people understand my perspective. there's an animating principles that firms can choose their activities but not their regulators. this is an animating principle
behind the financial stability oversight council. it's an animating principle that has been significantly and quite seriously attacked as a political matter. there's an animating principle that regulation must adapt to risk and that the perimeter must be flexible. this is another animating principle that has become very significantly controversial in the political system. it's important to think of this, not just as a financial stability oversight council issue, but also as a cfpb issue. it is no confident that the cfpb's rule on payday lending, which is the rule in which they go after a real risk facing real consumers but not one that is staff torle mandated by -- statutorily mandated by dodd-frank is the most controversial rulemaking they have done. and the last point is that statutes must create flexibility for oversight, not rigidity for arbitrage. this is a very contentious issue that in may ways prevented senator shelby who otherwise supported pieces of dodd-frank from being able to come on this bill.
he didn't believe that it should be part of it. it's a shared belief among the epublican caucus and has the rigidity in the system to the leadup to the crisis. i want to quote someone that helped me on the financial stability oversight council. chief risk office at solomon bridge bauer. you can read. there will be other crises. i want to spend time keeping the focus on what i call true shadow banking. i want to identify two different risks that are important to keep distinguished. one is what i call economic risk. in any given activity there is a set of risks associated with that activity, right? that's the standard risk-return approach. there is an additional risk which is often overlooked and i think particularly overlooked in the conversation today which is the risks associated with the ways in which you structure and finance that activity.
and true shadow banking is when you take risk in in economics sense and then structure it through the issuance of short-term credit. and that is an incredible magnifier, an incredible magnifier to risk we saw in the crisis and very big difference what we saw in the financial conference which to bill's point in many ways a run on private money as compared to other asset crises we had, for example, the -- the internet boom and burst in the early 2000's. i also want to make the point about operational risk. the single most important trend since the financial crisis is the substitution of credit and market operational risk. repo, i am very supportive of this trend. i actually think it's a good trade. but triparty repo used to have on the order $4 trillion of unsecured intraday credit.
that has come down naturally through the crisis to about $2 trillion and now has been restructured to allow for automatic substitution of clattle rale which means the actual credit that is given through the triparty repo market is only about $200 billion and needs to be preunderwritten and precommitted so that means we have on the order of $1.8 trillion of operational risk running through the triparty repo market. i think that's actually a terrific change for our financial system but it does mean that we have very significant operational risk and the practice and the theory of measuring it and mitigating it is still very much inins infancy. hi frequency trading is another good example. the way those traders can manage to take risk during the day, they rely on the operational capacity of their algorithms to get flat during the day. what used to be a line of credit to your broker-dealer is now an algorithm to go flat at the end of the day. that's an operational risk. obviously i work, so broadly
speaking, blank tech, office -- back office tech. this is a part of a large trend that's happening. software is feeding the world. i think in general there's a lot to be gained in this zone but we have to keep our eye on the risks that naturally are associated with it. i will just say the most important financial stact risk we face is cybersecurity. financial stability risks happen when people assume one thing and then are rapidly forced to assume a different thing and to believe a different thing. and the one place in our financial system which could create that most rapidly at this point is cybersecurity. at this pount i do believe that people -- at this point i do believe that prices can go down. i think people understand that cybersecurity is real. i do not think we are sociologically prepared for the severity of the kinds of cybersecurity risks that we could face if we have the
cybersecurity equivalent of 2008. so with that i will close and take questions. mr. wallison: thank you. right on time. any comments from the panel? alex? mr. pollock: thanks for very interesting comments. thank you, particularly, picking up on the financial markets or the financial sector. this may not be a system as an adaptive recursive thing. and your point, of course, is exactly right. it's made out of human beings. thought that was implied but i should have made it complicit. it's more -- it's more interesting than natural systems because it's made out of human beings. and two things you said in your comments which showed this is your emphasis on beliefs, what s believed by actors, and your emphasis on faith and what
faith actors have in various things which may not be true. just emphasize this interactive system made up of human beings. i just add one thing on this point which is that all the human beings are part of the interactive system. it's not the case that private an ncial actors are emerging surprising world and that the regulators and central bankers and politicians are somehow above that, able to watch it and understand it and know what's going on and fix it . all of the regulators and central bankers and politicses are themselves in the inter-- politicians are themselves in the interactive system, causing and being changed by the interactions. that's important to understand.
it's often at least in common language not understood. mr. wallison: any other comments on the panel? let's go out and get someone who hasn't. yes, sir. >> peter rogers, retired software executive. i was doing relations for my company for 20 years. the company had taken up by oracle four years ago. i remember about the time about bear stearns, i either heard or read during the quarter they would have a leverage ratio up to 70-1. they would clearly bring it down at the end of the quarter for reporting purposes. i find that interesting. i don't know if that's true. i think it was pretty high. when they fell apart, people should go to jail, help them bring bear stearns down and if their leverage ratio was so high, smart people short of the stock and the king had no clothing. i wonder what their leverage
ratio may have been intraquarter. mr. gerety: i am not sure about the exact magnitude. the general dynamic is true and you can see this if you look at money market rates they'd move quite significantly at the end of the quarter. it was actually a surprisingly difficult reform to put through to get daily average ratios instead of quarter end markers. but it just goes to an interesting point. i believe, although someone in the audience may correct me, we have now moved to, at least for those holding companies regulated by the federal reserve, to measuring leverage on a daily average basis rather than a quarter end basis but that was a reform that came nto place post-crisis. >> fannie and freddie were the leverage leaders in the whole world. even their leverage -- and alex alluded to it, was illusionary.
treasury hired i think morgan stanley to go in in july, 2008, after their regulator is either f.h.a. just as it was changing said they were not only adequately capitalize and they didn't believe it. mr. pinto: they sent a team in. when the team came back they said every rock we turned over, there were worms under it. they really have no capital. because they had all these tricks they were using, including they were selling bonds to the banks who themselves were levered on those preferred bonds. so they were clearly the leverage leaders beyond anybody else. >> i can add, if you imagine the firms hadn't agreed to the conservatorship that they tried to fight it in a sense secretary paulson under hera put taxpayer money into them as the treasury ultimately did with the -- mr. swagel: imagine if he walked out in the public. as ed said, we looked carefully at these firms and just repeat
everything i just said. the firms would collapse that cond so -- >> [inaudible] >> let me ask you what role market accounting should play in these situations, particularly where there's a crisis developing and extent does that mall anyify the crisis -- magnify the crisis? is there some type of accounting or regulatory trnt to mark-to-market accounting that won't exacerbate a situation that could lead to a risis? mr. garrett: i spent about six or eight months inside of treasury in the late 014-2016 time frame when we were looking
at the course of what had been done. the course what had been implemented. the risks still out there. we were trying to figure out a way to chart a new course. the unfortunate reality for me i was not smart enough to chart a better course. there's very good arguments on both sides. you know, cost basis accounting is essentially lying the day after you make the purchase. and thereafter. fair value accounting is deeply procyclical. i'm not sure what the better solution is. maybe others have better ideas. >> what should the regulators do? when you are sitting there in, particularly in a crisis situation, and you have a lot of selling going on, do you take the current market values literally or do you, you know, kind of fudge a little bit in order to get a better overall
outcome? mr. swagel: every night at treasury we would look at bank regulations for tarp capital. didn't make lators banks reserve enough for losses. maybe i shouldn't have been surprised. i was. . pinto: it's an old phenomena. my favorite instance was in 1982. mr. pollock: first mexico and then many sovereigns unfolded their debt on the u.s. banks. paul volcker said we're not going to write down these loans even though they obviously should have been written down. we're just going to keep them
at par, and moreover, we're going to call up all these banks and tell them not only are we not writing them down -- and also tell that to the examiners -- we're going to tell the banks, you are going to participate in the new realms of financing because we want to keep this game going. well, that's a fundamentally political and very high level political decision and gamble which was made. we're going to be better off if we don't recognize these losses now, we'll recognize them later sometime, which is what ultimately happened. >> [inaudible] >> in most countries when you choose your activity, you automatically choose your regulator, isn't it time that situation was the same question facing all american financial institutions? so you have no choice of regulation once you've chosen
your activity. secondly, you talked about -- i think it was a nice place to stop actually for you. you talked about being -- whether or not we were sociologically prepared for cyber risks. even if we were so prepared, how could that risk be mitigated? mr. gerety: so talking a little bit about the choice of activities, we have certain pieces of our regulatory architecture which are activity-based. one of the interesting dynamics that's happening right now is a -- not to bring cryptocurrency into the debate -- but one of the advantages of securities law is that it is functional and therefore whether or not an entity claims there's regulatory uncertainty, it's litigateable, it's governed by quite functional statutes so
given cryptocurrency is in fact a security is not a question that actually needs regulatory guidance because of the structure of securities laws. now, that's not to say there not be future guidance but just as its core, it's already well established in law. with things like banks that are chartered, and in particular in a span of now 50 years where we have not policed the boundary line for what it means to take a deposit, firms are now very much able to choose their regulator independent of their activities. so you can choose to be a money market fund. you can choose to be a broker-dealer who funds in the money market. you can choose to be a bank. many people have argued this is a failure of policing what is established law, but in any case, the financial stability
oversight council's approach to this, it should be policeable at a level of significant risk. so that was sort of a move very significantly in that direction but it's been a move that's proved very controversial. n the sewsology on cybersecurity -- sewsology on cybersecurity, one -- sociology on cybersecurity, it is -- this was a hub that i was in, i think it is interesting when you ask people to prepare, when you ask people to go through exercises and you explicitly talk about cyber, there is a willingness to forebear in private markets and in public policy that's slightly different than the willingness to forebear in public markets when it comes to funding. i saw instances -- now, these are not live instances. these are tabletop instances
where you would write the scenario of a large financial institution no longer being able to make or receive any payments. now, if you had a large financial institution that was no longer to make any payments, they would be insolvent tomorrow, they would file for bankruptcy the next day, right? but when the scenario is presented in a cybersecurity realm, people were more willing to play through the exercise, and i think that speaks to some of the sociological preparedness that we have to undertake but we have to get used to the idea that what we have seen in terms of data breaches barely scratches the surface of what is possible in terms of the potential catastrophic effects. mr. wallison: other questions? yes? >> i really liked this presentation because it calls to question of whether or not we are looking to another significant dislocation in the
foreseeable future coming through the housing markets. you seem to have a very positive view of the efforts to email undertaken rate the situation. i say your confidence in fen tech is terrifying. i would contrast that what we heard from peter, systemic risk is rising, you still have the government backstop. so this is for anyone who would like to answer which is -- if your view of the world that basically the risks are significant -- i think we're thinking about the old human risks that we're aware of, though many things have been
-- just defaults at g.s.e.'s, that's not a problem. they will probably get more money like always. foreclosures out in the real world, what's your thinking bout that? >> i know ed has some things to say about systemic risk and the housing market. january, 2007, 2008, what percentage of banks' loans are -- were real estate related? for small banks, 75%, for large banks, about 60%. what is it today? i would say it's about the same. the question is, what would a banker from 100 years ago say if you brought him back and said, oh, by the way, our banking system looks like that, he'd have a heart attack and say that this is not what banks
are supposed to do. mr. calomiris: they are supposed to be highly -- highly cyclical and highly liquid loans. it's not just the g.s.e.'s and it's still our banking system. by the way, it's always in. in the u.s. we had 17 financial crises and almost all of them major banking crises, almost all of them had to deal with real estate. by the way, canada's had zero. they're complex up in canada too. they are not as complex as we are. they're obviously very complex. it does turn out to be pretty simple. it's real estate. mr. gerety: canada has solved their too big to fail -- the reason is because there's no separation between the canadian government and bank. mr. calomiris: there are five large banks that are recent. i am talking history of 200 years. the problem is we have a real estate problem in the u.s. and
we still have one. later? >> ed's got to talk. mr. wallison: let's go to the next panelist but actually that was -- that question was excellent introduction. the question is why are we having these risks if most of the problems have been solved? why is -- why are -- why are mortgages or housing prices rising so quickly at the same rate or close to the same rate they did before the 2008 financial crisis and most people seem to believe that had something to do with the 2008 financial crisis? so we've had 10 years during which we should have solved this problem. maybe it isn't a problem. or if it is a problem, why is it still a problem? i'm going to turn it over now to ed pinto who believes it's a
problem, i think. and let me tell you a little bit about ed. he's the co-director of a.e.i.'s center on housing markets and finance. active in housing finance for 42 years. ed was an executive and vice president and chief credit officer of fannie mae until the late 1980's. has done groundbreaking research on the role of the federal housing -- federal housing policy in the 2008 mortgage and financial crisis. he joined a.e.i. in october, 2010. ed. mr. pinto: thank you, peter. first of all, there's some handouts on the table that includes a blue folder that has some of the documents that i referred to from the 1990's and early ought years. this started in 2004 or 2003, not true. second of all, documents i
wrote seven years ago, forensic study on the financial crisis is in the binder -- the bound bounder with the spiral. -- bound binder with the spiral. i say that fannie and freddie were the leverage leaders and also mispricing leaders. we can look at countrywide and countrywide was paying about 12, 13 basis points for the guarantee fees, the guarantee that fannie and freddie was providing. countrywide was the largest customer of both. just the cost of keeping the doors something was something like eight basis points. they were really not counting anything for credit risk. one of the comments that's been made and throughout the discussion today has been about the federal -- the federal reserve role. you really have two punch bowls and i think where the fed missed things was they never connected that their punch bowl was side by side the fannie mae
punch bowl and they were both being spiked at the same time. fannie mae, as steve went through, the fannie mae, freddie punch bowl is going pretty quickly. the fed is draining that punch bowl. every time the fed starts lowering interest rates, fannie and freddie just keep growing until they finally slow down a bit but they keep growing up until 2003, 2004. we only have to look at the 2003 year which there was $8 trillion of mortgages outstanding at the end of 2003 in the united states. how many were originated in 2003? $4 trillion. i made the statement, i don't believe in the history of the world you've ever had half of the mortgage loans in the country turn over in 12 months. but that's what happened. who were the biggest participants in 2003? fannie and freddie. so with that, the 10-year anniversary, the actual causes continue to be largely ignored. diagnosing it correctly is of
vital importance, as peter said. there was an original and continuing misdiagnosis. deregulation, the private sector, market failure. we're really talking about, what -- why did it happen? this led to incorrect prescriptions. massive new sets of regulations including qualified mortgages, qualified residential mortgages. i'll come back to that in a few minutes. and an expanded role for the government's subprime lender, f.h.a. the result has been a slow recovery, financial regulatory failures, the same flawed affordable housing policy that we had for 60 or 70 years but it was doubled down in 1992. the correct diagnosis is that the government policies forced a systemic loosening of underwriting standards throughout the industry in an effort to promote affordable housing. the price boom one was due to the misdiagnosis, we are now in
the middle of price boom two. price boom two was foreseeable. peter and i both wrote op-eds. one was in early 2013. the other was in spring of 2013 which said the q.m. rule would set the next rule for the next price boom because it didn't limit leverage. the housing market in 1992 -- if you see what it was. when congress basically upset the apple cart. the mortgage market, three separate segments. conventional, f.h.a., subprime. homeownership rate was 6.8 times. mortgage rate 9.5% eventually goes down to 6% by 2006. federal housing enterprises, financial safety and soundness act, anything named that you have to be sprishes of. was a miss -- suspicious of. was a missed diagnosis. houses were affordable. they made them unaffordable.
and h.u.d. wore many, many hats. fannie and freddie were -- they were involved in the prime market and congress said that's not going enough. you have to go into competition with f.h.a. and with the private subprime market. that was a huge sea change. i speak of some knowledge. i was chief credit officer at fannie mae up until 1989. this happened three years later. i know what the standard was. the real cause of the financial crisis had to be misdiagnosed because it would have exposed a second -- as fredric called it, fatal conseat. the fatal conseat was the federal housing policies. we had a federal housing policy that detriment of universalizing wealth by universalizing credit. the s a quote from 1850 by economists -- economist bestadt. he said you can't give credit to everybody because you're not increasing supply.
we did virtually nothing to increase supply. we had a reliance on increasing affordable housing borrowers leverage. we did it on the cheap. relative to nonaffordable housing borrowers in a vain effort to make housing more affordable for those select borrowers, but no on budget expense and little consideration of supply constraints. so this so this creates this economics-free zone on one side from the government system, and then you have, i forget the term used in terms of what thes whoing market is actually a -- housing market is actually a market. subject to supply and demand is being implemented by real people make six million decisions a year which is -- 12 million decisions. six million to buy, six million to sell. again, the facts speak for themselves that homeownership rate was virtually unchanged since 1964. you can almost say it's virtually unchanged since 1960. so what have we accomplished? housing policy was doomed to
failure because of these laws of economics. i won't go through them. they're on the slide but they basically show, while you can't have this market on one side and this system on the other, operating in any way that will do anything other than drive prices up. so correctly diagnosing the financial crisis in light of these principles, steve noted the origins of the unprecedented credit loosening by fannie and freddie and this is largely as they shifted from prime. so even the d.t.i.'s went higher too. even the down payments reduction, that was a shift from prime loans to what would become subprime loans. they were much like f.h.a. loans and other than they were like the fannie and freddie loans. so the subprime explosion starts in the early to mid 1990's. the affordable housing mandate law launched a long cycle, concepts of comparative advantages, starting with fan
i's trillion dollar commitment -- fannie's trillion dollar commitment. this is a trillion dollar commitment. one of many, many, many trillion-dollar commitments. so as steve noted, despite the jump in risk of risk product features, leverage accounts for what happened. important messages we'll see for what's going on today. there's an abundance of smoking pistols that occurred, that should have made this misdiagnosis impossible. but for the reasons of the fatal conceit, no one wanted to recognize that's what happened. you can't really make this stuff up, much is written about what happened after the fact, that very little is written about what actually happened during the run-up. so it starts with president clinton and the national home ownership strategy, which i think alex mentioned. i am committed to a new and unprecedentialed -- unprecedented partnership with industry leaders and community leaders and the government to recommit our nation's home ownership.
it will never cost the taxpayers one extra cent. it will not require legislation or add more government programs or grow government bureaucracy. 1994-19 5, the jim johnson trillion-dollar commitment. i will transform the housing finance system in the united states. h.u.d., a press release in 2000 describing h.u.d. everybody says, oh, h.u.d. didn't have much to do with it. papi congress. h.u.d. was the -- poppycock. h.u.d. was the riskiest lender in 2000. a press release from information provided by whom? h.u.d. 2002, a victory lap over f.h.a. he says the government is our only competitor when it comes to public funding for housing. we have defeated f.h.a. given president clinton's 1994 call to action by all of these parties, the report to congress that h.u.d. came out with in 2010 can only be called --
somehow the mortgage industry participants appeared to have been drawn to encourage borrowers to take on riskier loans. excuse me. they were in the middle of this. the key to the machine gun diagnosis -- misdiagnose was ignoring the goals. the special affordable goal is very important. the goal goes from 40%, it was at 30% before h.u.d. set the goal, that was an interim goal in the statute, it eventually goes to 56%. but it's at 40% in 1996. but the special affordable goal, for even lower income than 100% of median income down -- 100% down to 60%, was even a larmer goal. that goal went from 12% to 27%. in fact, virtually every percentage point increase in the big goal was in the special affordable goal. so what they're doing, with every change in the goals is
ratcheting the requirement that you dig deeper and deeper and deeper and provide more and more leverage to get those borrowers to the table. so one sees this tension in the stress default rate that steve presented today. there's a resumption of substantial growth in 1999. some people point out that, oh, that proves that the goal has nothing to do with it. except that andrew cuomo called fannie and freddie in separately in 1998 and said, i'm going to do a huge increase in the goal. just want to give you a warning. and it turned out he was delayed for a year. the increase, which you see here, shows up in 2001. but he told them about it in 1998, 1999. they have to start preparing for it. this is a battleship. you can't change the battleship and go from x percent to y ners one year. you have to prepare for it a year or more before. the g.s.e. share during the
run-up, steve talked about the purchase side. this looks at the g.s.e. share of all mortgage originations, including their share, the urchases of subprime and alt-a private mortgage-backed securities and you can see that for everything, including refinance, their share basically doesn't drop below 40%. it's as high as nearly 60% until the crisis hits when it goes up a lot. it's always higher than the private mortgage-backed securities market. unlike the chart on the right side, which was put together by the financial crisis inquiry commission. this misdiagnose led to dodd-frank which then spawned new regulatory failure. which look no further than the -- we look no further than the d.t.i. patch. the d.t.i. patch was put in place in january, 2013, by the bureau of consumer financial protection. consumer financial protection.
what does it say? fannie and freddie, f.h.a., v.a., u.s.d. are exempt from the ability to pay 43% for eight years. until 2021. that was their idea of consumer financial protection. after they had researched and found that d.t.i. was a critical omponent to a low-risk loan. the next slide that i'll get to shows that rather than undertake , orderly transition period the same agencies took advantage of it with one exception and actually grew the percentage of loans over 43%. so here's fannie that shows boom one and boom two. g.s.e. share above 42%. and it shows the pattern very similar in terms of the blue is the fannie share, excuse me, the
g.s.e. share. the red is house prices. you see we have the same pattern both times. that's why we call it boom 2.0. it's following the exact same pattern. why? because the bureau allowed all of these entities to avoid or violate the rule that they said as so important. this is another view of that, which looks at each individual institution or agency along with the private sector. you see the private sector, which is at the bottom, is actually declining in d.t.i.'s. whereas house prices have been going up. and rural housing has also been declining. they're the only ones that took the bureau seriously. the other four said, opportunity to do what we always do. expand leverage. i didn't have space to show all of the refinance charts. we have refinance charts that show cash out refinances going through the roof in terms of
d.t.i.'s by these agencies. correct diagnosis requires having the tools for monitoring the role played by government financing and affordable housing policy. that's why steve and i created the center. when we looked at this in 2013 and we said, we got to measure this. and it wasn't measured the last time. the way you measure it is through these periodic tables that we developed with alex's -- and peter were also instrument nal that. so we said, we have to -- instrumental in that. so we said, we have to look at the role of leverage. you need a yard stick. delinquencies are not leading indicator. they are not a leading indicator. for the reason that as house prices go up, delinquency goes down or stay stable. therefore you can't use delinquencies as the proof that, oh, everything's fine. you have to look at the absolute level of risk. we created a yard stick which we
call the periodic table. based on the 2006-2007 event. so our latest research, which is ongoing, confirms two things we've been worried about. governmental policy decisions are once again driving excessive leverage in house prices. and not surprisingly, the same policy decisions leave entry level buyers and taxpayers again exposed to the risk of house price decreases. so the fact that that happened last time, we haven't learned that lesson at all. how do we know that? 28% of their en loan hen -- loans or over 50%. i have a series of slides. i won't go through them all. they basically demonstrate boom 2.0. lide 14, 15, 16, 17, 18 is one that shows the concentration of these loans on a map. this is phoenix. remember, phoenix was one of the ground zeros. hasn't changed. the high-risk loans are still
concentrated very high-risk loans by f.h.a. and fannie mae and freddie mac. we know the private sector isn't participating in this. how? because, a, their shares are so small and their risk is an average of 3% on our scale. which makes them on average low-risk loans. f.h.a.'s at 28%. 21, 22. 18 or 19, 20, so i'm going to go to 23. which is the correct diagnosis. the only plausible reason for government to back the housing market is to help low and moderate income families buy homes. the g.s.e.'s fail this very simple test. almost half their volume isn't related to buying a primary home. full stop. and then very little that is there to help people of moderate income or low income buy a home with a modest down payment. so, the correct diagnosis, slide
24, is that this policy income cannot be justified given entry level housing is made less affordable by our policies. and taxpayers have, again, $5 trillion in g.s.e. debt. therefore we should take a series of steps to start reducing the size of fannie mae and freddie mac and we can start very simply and very directly by saying, you shouldn't be in the businesses that have nothing to do with buying a primary home. and that would cut their volume by, over time, 50%. and that would be a simple solution. it could be done in stages and it would have no disruptive effect on the market. it would certainly disruptive for the people that make money on mortgage loans. but it wouldn't have much effect on the marketplace. secondly, any government help that is provided, and this question, charlie talked about, should be for low-income first-time buyers, should be upfront, transparent, targeted, onbudget, one time, refundable
and advanceable and used to make loans less risky. care should be taken that whatever's done, there's sufficient assistance provided to intent some additional to supply to offset the increased demands so so as to avoid the upward price pressure. i'm done. [laughter] >> someone can admit defeat. [laughter] >> alex, i didn't let you make a comment before. i feel very badly about that. although you've done it to me many times. [laughter] would you say what you were going say? >> i will. the function of banks is to make everyone else liquid, both with loans and deposits and they do this by themselves being fundamentally illiquid. because they're making everyone else liquid. what makes them most fundamentally liquid is real estate. just as charlie and ed said. one thing that hasn't come out
is that when you look at the concentration of banks in real estate risk, loans, which charlie accurately recited the numbers, but there's an equal concentration in securities. so if you look at the securities portfolio of banks, because of fannie and freddie, they're equally concentrated in real estate, as are the loans. >> ok. anyone else on the panel would like to say something? >> thank you, peter, for letting me say that. >> ok. i feel good now. yes, sir. and then others around. yes, sir. questioner: hi. carl. just a brief follow-up to a question i raised at lunch. monetary issue. you mentioned the word money. you mentioned measuring things. that we measure things in terms of trillions of dollars and billions are just now a rounding error. and just for context, the word dollar we get from the belgian word toller, which was to
describe a silver coin that circulated as money for 400 years. and in our constitution, the only measure of a dollar was a certain weight of gold or silver. so we have an accurate unit of measure. so i just ask, what should the word dollar mean in today's world? what is the meaning of the word dollar? >> paper is what it means. [laughter] >> the thing that the federal reserve has a monopoly in producing. >> sounds like more of a statement than a question. >> trick question. >> i teach international macroand we look at the exchange value of the dollar and we look at inflation. those would be the two ways of looking at it. >> it should be a unit of value which over time is stable, although sicklyically it goes up and down. so that long-run inflation is
zero and sometimes it's positive and sometimes it's negative. but over the long run it's flat. that's what it should mean. >> hi. nother excellent presentation. fannie and freddie, it's like a triad between them, the banks and the fed. if the fed creates money, it goes through the banks. they offload some of that to fannie and freddie. but if the banks aren't lending in real estate, where can they lend? because as a corporate finance person, they're not competitive hardly in any other sector. so it's got to transmit from monetary policy to real estate. >> i'd like to -- >> ok. >> i think that you may be right. that the banking system, the chartered banking system, might have to shrink if the proportion of letting real estate were constrained. you might be right about that. but it's not obvious that it would shrink. they do have a comparative advantage in small business lending still. and they also, because of their
payment system link, will always have large corporate lines of credit. so i don't think that -- they may have to shrink but that's not necessarily -- there's no reason i can think of that the current banking to g.d.p. should be our desired level. >> remember, when we're talking about going into real estate, what you said is true of foreign inflows as well. when you get big shifts in foreign investment, it very often goes into real estate. especially if the real estate has been made to feel completely safe by government guarantees. what you're really lending against is not the real estate but the price of the real estate. we can only get it into our heads that it's really the price of the real estate which is your investment. it might cause us to be more prudent. >> not creating more. >> that's right. [laughter] but we can create big price
run-ups, as edward demonstrated. >> ok. question? >> what do the canadians do that we don't do that they're able to avoid banking crises? >> i'm not going answer that question. but i will recommend that you read a book all about it. [laughter] >> what book? >> "fragile by design." it talks about canada in particular. >> that was a set-up. >> i'll tell you. >> [inaudible] [laughter] >> good. any other comments on the panel? any other comments, questions, book promotions? ok. bill. e have five minutes. >> one of the things that troubles me most about this whole situation, i think we
understand the politics of it. at least at some level. but i worry a lot about our professional colleagues. how is it that economists are not seeing in the way almost all of us in this room see it? there's something missing there, i think. that our profession is just not facing up to the realities of the data that we have. i worry about that a lot. >> you don't -- i can answer it as a professor. you don't get rewarded as a professor for saying obvious things that everyone knows. and so the -- i mean, i'm not joking. right? you know this too. >> that's left to people in think tanks. >> exactly. [laughter] >> go ahead. >> i think i can stop there. if any of you don't understand the incentive structure in the academy, i'd be very happy to
explain it later. >> i think it goes another step further than that. and that is that the standard way that economists look at things is to get a data set, first of all, they don't know much about the topic. we're talking about mortgages. their knowledge of the mortgage market is pretty skimpy. to start with. they may think they know about the mortgage market but they really don't have any in depth experience. secondly, they come up with a data set which the papers i've looked at, most of the time it's the wrong data set. then they come up with moodle that shows something or other. and that's usually flawed. then they get a result and even if the result is crazy, they don't know the difference and so one or more of those things tends to happen on a lot of that research. they don't tend to do the kind of research, those slides i went through, they don't go through that type of research which is, let's create a really robust data set that's got virtually all the loans in, it all the transaction, all the waiting, all the this and that and let's see what's happening in the real world. they create a model.
we don't have models. >> i want to interject one more point. remember that there was a book called "fractured finance" that is pretty much an agreement with what we're saying. and colleagues at n.y.u.-stern wrote a book that is in agreement with that. using slightly different data. but reaching the same conclusion. so i actually think that if you look at -- now, they didn't write referee journal articles because referee journals don't publish articles that are like that. but i think that there are examples. >> [inaudible] >> the problem is, you know, i don't know what the progress is because it's a political problem. jeb hensarling can invite me to testify and i can say all these things and then the republicans and of course all the democrats completely disease like the idea of try dislike the idea of trying to make this connection but the majority of republicans don't like it the. it's basically a divide between rural republicans and everyone else. urban republicans and democrats
are all on the housing subsidy side. -- i think the the friedmancepted schwartz diagnosis after a few years. there are very, very few economists who believe that the stock market crash in 1929 caused the great depression. for example. but -- so that work made a huge difference. and people refer to it all the time. and we have in place a great deal of information about the financial crisis. a great deal of information about the financial crisis. from a variety of different views. >> but as you know, the friedman schwartz book was written in 1963. the great depression happened
from 1929 to 1933. so maybe the fact that you're taking this topic up right now means that your student will write the book that finally convinces people. >> i interpret the friedman schwartz contribution as reflecting -- i mean, they did a tremendous amount of data gathering. -- then they had some particularly milton friedman had a very, very clear idea about all of this. but they were very convincing. it took them a long time to put together the data and the argument. the book was published in 1963. and that is decades after the end of the depression. but here in this case we have an enormous amount of information available pretty quickly after the financial crisis. we have information that's come from the inside of fannie mae
and freddie mac. we have all the loan level data. we have peter's work. we have work from both sides, across the political speck prum. -- spectrum. but yet we are not convincing, we are not convincing many of our colleagues. i referred to one of your colleagues at columbia, the historian. but -- so people are just not looking at the available information. and that's why i said at the beginning, there's a great deal of scholarly malpractice in place here. >> let me -- i started this whole thing today with a statement that it's going to be very, very hard for us to know, fully agree, as people have now, almost fully agree, on what happened in the great depression. that was friedman and schwartz.
it's going to be very hard for us to know only 10 years after the crisis what caused this crisis. and when i say no, i mean, most sensible people coming to agree. and one of the reasons that that's difficult is because it's now caught in a political squabble between left and right. so we have to get beyond that. maybe 30 years from now there will be a friedman and schwartz who will come in and read all the stuff that you've read and there won't be any people around , maybe me, i'll be around. [laughter] but there won't be any people this is say politically fraud. you're wrong, you shouldn't be saying that. it's out of sight. so, that's what we have to wait for. that time to pass so the politics are not as heated. and then the scholars can come in, hopefully using some of the
things we heard today, and make a judgment. and i want to thank you -- >> just add one thing. it relates to the founding of a.e.i. a.e.i. was founded in 1938 and it was founded in order to make sure that free enterprise did not disappear in the united states. so when you look at how long it took to get the right answer, that was against the current of -- an approach where nationalization of this, expand government programs of, that the whole new deal and all of that stuff was actually viewed as that was the solution against this view that private enterprise should be thrown away . and a.e.i. was founded in 1938 to push against that. i think -- so that's not too different than this fatal conceit we have now on affordable housing. same thing's going on and it's still too close. we have to get far enough away so that people can actually see this whole thing is just rubbish. >> that's not the note i wanted to end on. [laughter]
i want to thank all of you. we all want to thank all of you for coming in and staying for really eight hours. nine hours. so thanks so much. i thought it was a very interesting conference and we had some -- all the panelists were wonderful and articulate and expressed themselves well. we all learned a lot about it. so thanks. [applause] [captioning performed by the national captioning institute, which is responsible for its caption content and accuracy. visit ncicap.org] [captions copyright national cable satellite corp. 2018]
>> live today, chef jose andres will talk about the world central kitchen and efforts to feed people in puerto rico after hurricane maria. live coverage begins at 7:00 p.m. eastern on c-span. and on capitol hill, the senate returns for business monday at 2:00 p.m. eastern. lawmakers will debate a bill to combat opioid abuse. and another on drug pricing transparency. a final vote on both measures will take place at 5:30. the house returns september 25, continuing work on 2019 federal spending, including an extension of government funding to december 7. current funding expires at the end of the month. as always, you can watch the house live on c-span and the enate live on c-span2.
>> washington post reporter bob woodward is our "washington journal" guest monday at 7:00 a.m. eastern, talking about his new book, "fear: trump in the us who." then on tuesday at 8:30 a.m. eastern, ken starr joins us to discuss his book "contempt: a memoir of the clinton investigation." watch next week on c-span's "washington journal." host: emily atkin at our table this morning. staff writer for the new republicans. wrote several pieces of late about the hurricane. hurricane florence as it makes landfall today. she'll take your questions and comments here this morning about preparedness. that te on july 17, nearly five million households registered for fema assistance in 2017. more an the previous 10 years combined. the wildfires in california were their