This comes from the Real World Economics Review Blog. It is a map showing one zip code on Chicago’s South West Side, 60629.
This neighbourhood has been gutted. The red dots represent all of the properties in that zip code that are either in pre-foreclosure or are already bank owned:
If you want to know what market failure looks like, that is it.
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No, this is just a failure of Clinton’s policy of encouraging banks to lend to people with poor credit, and of encouraging low income families to purchase their own home.
@Greg
you are clearly determined to get this comment on this blog.
You are all so clearly extremely misguided.
Low interest rate policies are beneficial for society, and I warmly welcome them. They reduce the cost of capital, encourage investment, create employment , and enhance well-being.
your claim that this resulted in the housing boom and bust is entirely false. Absolutely no one required banks to lend to anyone who could not repay, and proper bankers would not have done so. But because bankers chose to lend and then sell on their risk to others, who were not aware that the products the banks had supplied were to those unable to meet their obligations, bank earned false profits, and upon realising they could do so continued to exploit the vulnerable in society by continuing to sell loans that people were unable to service
This had nothing to do with housing policy
And it had nothing to do with low interest rates
It had everything to do with the collapse in banking standards and the in troduction of securitisation
Get your facts right
“your claim that (low interest rates) resulted in the housing boom and bust is entirely false”
Do you seriously think that low interest rates – in Ireland, in the UK -had absolutely nothing to do with the subsequent housing crash?
“Absolutely no one required banks to lend to anyone who could not repay”
And absolutely no one required lenders to borrow.
Absolute rubbish. And where have I mentioned low interest rates? And where do I mention boom and bust?
Clinton encouraged (some might saw forced) banks to lend to people with very poor credit levels. That is where the problem that you highlight at the start of the this thread began. Nothing to do with securitisation and nothing to do with CMO’s. Even if the mortgages hadn’t been sold on, they would still be non-peforming and the banks would foreclose. If you sell a NINJA loan (No income, no job or assets) then it is going to go wrong, irrelevant on whether the bank keep the mortgage on it’s books or sells it to a Japanese hedge fund.
That is why that Chicago neighbourhood is being gutted. Yes, the blame cannot soley be placed at the door of the loan applicant, and yes some should fall on the bank and (probably most importantly) the mortgage salesman, but it’s not the fault of the market.
@Tom Olver
low interest rates may have been a factor in housing boom. But they need not have been. Any prudent bank and not have lent. That is the whole issue. This was a market failure on the part of bankers, and nothing more or less, and it was possible because they could sell their risk to other people – and that’s why the market failed
All other explanations are entirely false, including that offered by Greg
as for the borrowers, you may have noticed the asymmetry of the power of the parties. Please don’t make fanciful assumptions that all are in possession of all facts. I know that the efficient market hypothesis is built on this assumption and it is utterly absurd
@ Richard, then banks were “encouraged” to abandon their prudent principles by Clinton, not by the ability to package and re-sell the loans.
Of course afther the whole process was started you saw the purchase of mortgage brokerages by the banks (such as Lehman) but the whole thing was started by Clinton. That is undeniable, and that is what I stated in my first post.
@Greg
and I disagree
Debate over
Richard,
It is really interesting that you are picking this zip code. I went to school for both undergrad (only freshman and sophomore) and grad years in the area, the University of Chicago campus is only a couple of miles to the East of Chicago Lawn (the name for the area of this zip code). It used to be a truly dreadful neighbourhood. So bad in fact, that all cab drivers would refuse to drive through it from Midway Airport to the UoC campus, at any time of day.
During the years after I graduated from UoC a lot of money was invested into the area in various re-generation initiatives. In particular local residents were given access to a range of subsidies for home financing. I am not entirely on top of the details of the scheme, but in essence Federal, State and City agencies would agree to subsidize and/or guarantee private mortgages.
It may have sounded like a great idea, but as in other places the availability of cheap subsidized credit encouraged homebuyers to acquire properties they could not afford. And this was made worse by the offering of sub-prime home equity loans allowing homeowners to leverage their equity during the times of rising house prices.
Politicians should have done something about it, but did not. Because of the area’s long association with the African-American civil rights movement, and because of Mayor Daley’s reliance on the black vote (not to mention a certain junior US senator for Illinois), the scheme was always heavily politicized.
So I am affraid that this is just as much an expmple of failure of government intervention as it is one of failure of the market itself.
The argument that the Community Reinvestment Act in the US created the subprime crisis is a notorious piece of rightwing trolling which has been totally discredited. See for example http://krugman.blogs.nytimes.com/2010/06/03/things-everyone-in-chicago-knows/
The US hard right have variously blamed Fannie Mae and Freddie Mac, Bill Clinton and even Jimmy Carter (in whose presidency the CRA was passed, in 1977) for subprime while conveniently ignoring the complete recklessness of the US banking sector. Anything to pass the buck, I guess.
– Banks were partly to blame
– Borrowers were partly to blame
– Government was partly to blame
– Buyers of these loans were partly to blame
‘No doc’ loans contributed to this mess, aided by willing buyers, all to willing to go along with the fraud, assisted by realtors, brokers and banks.
While the banks sold forward these dubious mortgages to willing buyers, the home buyers too were attempting to pass these homes forward as well, taking interest-only loans with the full intent of selling these houses before they were required to make their first payment against principal.
I moved into an established community that has a number of mcMansions dotted through it, built during the housing boom, either by enlarging the original ‘rambler’ or tearing it down and building the largest house that could fit on the property. During our last civic association meeting these houses came up and it was noted that every single one of these houses that was built has been foreclosed on, with the exception of on which remains incomplete.
No one ever forced banks to lend money to people who lacked the ability to pay it back.
It was greedy, unprincipled banks who failed to disclose to inexperienced borrowers the risk of taking out any form of loan.
Banks substituted prudence with greed – then packaged the risk and sold it onto to other devious bankers.
Blaming Clinton is about as absurd as blaming Isle of Man government.
Now there’s a thought …
Greg
It’s amazing how those poor families managed to outwit some of the best banking brains in the world. Surely it must have been a two-way deal, or did those poor families heartlessly screw the banks to the floor?
Fred Fry
Consumers aren’t economists; certainly not sub-prime consumers. They’re mechanics, hairdressers, hotel workers, waitresses, factory-workers who need somewhere to live. If they are being offered loans, often by their own bank with their statement, or through targeted mailings, advertisments on TV or in their newspapers, then it’s not surprising there will be some take-up of these offers.
“Phone free for a no obligation quote.” CallsmaybemonitiredfortrainingpurposesAllquotesaresubjecttostatusTermsandconditionsapplyYourhomemaybeatriskifyoudonotkeepuprepayments.
Ding. Ding.
@ PSG, one could flip your statement and say that no one ever forced people who couldn’t afford to repay to borrow money from the banks?
Yet people who didn’t have the means to support home loans were encouraged to take these out by greedy, unprincipled advisers (ring any bells?) AND by the US government and Bill Clinton’s policies.
The consumer obviously needs some form of protection (which is why licensed advisers exist) however caveat emptor also needs to apply. People need to be responsible for their own actions.
Please note that the housing bubble began not long after the stock market boom of the nineties ended….coincidence?
The way I see it….New production tecnologies have created an enormous amount of capital that cannot be easily or profitably invested in such traditional things as the manufacturing sector….specially in a country like the U.S that does not have an industrial policy. So the money goes anywhere it can,really. Bubbles appear first in one place, then in another….and they will continue as long as this glut of savings continues to circle the globe.
Today, most emerging markets are having a housing bubble….despite the fact that banks in those countries make it very difficult to qualify for mortgage loans and there is nothing like a subprime loan…
Like I said, the savings have to go somewhere…
@RichardSM
Amazing how it was all Clinton’s fault too when it was happening here as well
Fantastic how he got his grips into all economies
And it had nothing to do with banks applying the same policies in both places
@Cesar Esteban
Issue more gilts is the answer
That’s what they want
@RichardSM
Absolutely
Buy not to a libertarian
Remember their assumptions – everyone has perfect knowledge, all have perfect access to capital, etc etc
And if they believe that you can see why they come up with such stupid statements
And their economic policy is based on this garbage
Why is this a failure? The scale of the map is 500m:1cm, so it is quite a large area and not nearly as you imply. The risk of loss may have been fully covered in the margin and the equity investment by individuals, who have since moved elsewhere, may have been negligible so it proves nothing. Sounds like an area that no-one wants to live in so probably an area ripe for redevelopment for a more sustainable community.
IQ Levels as % of population
02.2% population = IQ 130+ – Exceptional
06.7% “ = IQ 120-129 – Superior
16.1% “ = IQ 110-119 – High Average
50.0% “ = IQ 90-119 – Average
16.1% “ = IQ 80-89 – Low Average
06.7% “ = IQ 70-79 – Borderline
02.2% “ = IQ 70 – Low
140 – Professors, Research Scientists, Top Civil servants,(R.Murphy?)
130 — Physicians and Surgeons, Lawyers, Engineers
120 — Accountants, Managers, School Teachers (some), Senior Nurses
110 — Electricians, Salesman, Foremen Policemen
100+ – Shopkeepers, Welders, Machine Operators, Hairdressers
100 — Warehousemen, Carpenters, Farmers, Drivers
90 — Gardeners, Miners, Labourers, Packers, Sorters
@Greg
The executive management of every bank sets company policy.
Everyone else in the bank’s pay chain are employees working to instruction.
If the bank’s policy is “greedy and unprincipled” then the employees are not culpable, they are merely doing their job – which may give rise to moral conscience…
As for “ringing bells” … the PSG has no contact with “licenced advisors” — only unqualified, unlicenced and unregulated advisors who were represented to members as “professional” financial advisors.
Another example of “greedy and unprincipled” policy Isle of Man style.
And Jersey and Guernsey are of the same fashion.
Exactly! Which is why Clinton’s policy was so wrong.
@Greg
‘People need to be responible for their actions.’
Agree. But I haven’t seen that many bankers, hedge fund managers, mortgage advisors, estate agents (realtors), etc taking much responsibility have you – apart from the odd high profile example, of course (e.g Goodwin), who almost invariably left with a very large golden goodbye and pension pot.
So, if were going to bang on about taking personal responsibility for our actions, which is now a constant theme in ConDem thinking here in the UK, lets ALL sign up to it shall we.
But that won’t happen will it, because the system we live in is nicely rigged to make sure that those with money can almost always wriggle out of whatever sticky situation they might get themselves into.
Let’s take one example from this weeks policy announcements – Legal Aid. Originally put in place to allow those with limited means access to legal services so that they could seek to gain redress or settlement if a range of situations arose. As of this week that option is no longer available to people of limited means across a whole range of scenarios. And so the system just got even more skewed.
Still, if enough people – and their cheerleading press – repeat the mantra that ‘we’re all in this together’ loudly and frequently enough its bound to con most of the people for some of the time isn’t it. But I’d guess that particular con trick will have well and truly worn off by late next year.
@Alex
The callous indifference of the bailiff on display again
@Greg
Note comment 9
I think a major cause which hasn’t been mentioned is that – and I my be wrong – under US law I believe a person in negative equity can simply walk away from the loan. The bank takes the house and the borrower no longer has any liability for the loan. But as soon as one property in a street is epty because the bank has foreclosed on the loan, it depresses the value of other houses. So other people fall into negative equity, and the problem gets amplified.
Perhaps I am mistaken, but if correct, that seems to explain the contagion set out so graphically in the picture above.
@Richard Murphy
Actually the assumption is that the information is broadly the SAME, but NOT that it is perfect.
And that only ONE market participant, NOT all, has access to sufficient capital to exploit arbitrage opportunities.
There have been thousands of papers to examine the impact of imperfections such as uncertain information, frictions, transaction costs, time delays in access to information, capital constraints, etc., etc.
There is even a guy at the UoC, 10 blocks to the East of the zip code you are displating, who has looked into the impact of psychology and behavioral patterns on price discovery in asset markets.
And all this body of work has not managed to disprove the hypothesis that markets are efficient.
Re my earlier post and reference to the changes to Legal Aid. I hadn’t spotted this article at the time. Fairness, responsibility, don’t make me laugh!
http://www.guardian.co.uk/commentisfree/2010/nov/16/legal-aid-cuts-law-access
@Cesar Esteban
I advise you to take a look at Michael Hudson’s website. He explains there how so called quantitative easing serves one purpose only: asset price inflation. Through the carry trade (arbitrage of low US interest rates and high BRIC interest rates) instead of the intended inflating of US asset prices, the dollars are flowing into open BRIC markets. They are not going to put up with it forever.
@Carol Wilcox
That is not a completely correct argument, I’m afraid.
There is no doubt that aQ E can give rise to asset bubbles and that it may have done so
but let us also be clear: QE is simply the state is doing what commercial banks normally do, which is the creation of money. It is no more or less harmful than banks doing that
And when there is a shortage of money supply hindering economic activity then someone has to create more money
But I do believe that it is better done by spending into the economy, rather than by repurchase of gilts
@Million Dollar Babe
oh dear, wrong again
You can prove for ever on a blackboard that markets are efficient if you make the assumptions I note (but not yours)
the truth is, what ever assumption you wish to make, and how ever youadjust the formulas, markets do not move towards equilibrium, they do not embrace fundamental uncertainty, and they are not efficient. Just look around you. Your eyes are an amazing analytical tool, but you refuse to use them
Actually, QE is printing money for the financial sector only, as Hudson explains.
The cover story is that if the banks feel comfy, then they’ll lend to the little people, the reality is that they use it to speculate.
It doesn’t actually enter the non financial sector, or as humans refer to it, the real economy
@paul
Sure – that’s the way it has worked
But that’s not cast in stone
I hope to have an alternative out very soon
@paul
QE allows the banks to create money out of nothing.
Some of this money is retained as “bank reserves” – a figure based on prescribed percentage of the banks deposits, usually 10%.
The balance is considered “excessive reserve” and can be used as the basis for new loans.
What really happens is that “excessive reserve” is created out of thin air and this is how the money supply is expanded. The banks do not really pay out loans from money they receive as deposits, if they did this no new money would be created, instead they accept promissory notes in exchange for credits to the borrower’s transaction accounts.
Once a loan is deposited in another bank the money (less 10%) then becomes available to the bank to make further loans — and so the process repeats and repeats.
In otherwords the money is created out of nothing simply because there is a demand for loans and there are “reserves” available to meet this demand.
In the USA only 3% of the money supply exists in “money” the rest exists on computers alone. All banks exist by manipulating loans — in fact the whole financial system is based on loans and because these loans that are now almost infinite in number and impossible to trace it is not feasible to refer to them as the “real economy”.
Just what is “real”?
Greg
How did Clinton get UK banks (Barclays, Royal Bank of Scotland, HBOS, Northern Rock etc.) to do the same in the UK? Or Allied Irish Bank in Ireland?
Michael Hudson is talking specifically about US QE. It doesn’t do what it says on the tin. The banks are not lending for production, just speculating on developing countries’ assets. But it isn’t working here either. The lowering of interest rates is a separate policy which has been useful.
Martin Wolf was saying in the FT last week that QE2 would not do any good but it wouldn’t do any harm either. I think he is wrong. He is extremely critical of Obama since, by appointing the same old guard, he is continuing Bush-lite policies.
Oops, last post was muddled. Wolf was not critising Obama at all, it was Michael Hudson.
I think you’ll find that in Guernsey you have to be licensed to give financial advice. I presume it is the same in IOM and Jersey.
@Richard Murphy
Funny.
If we only used our eyes for analysis, we would all believe that the Earth is flat, wouldn’t we?
The situation is much more complex than your statements that “the market failed” and “it is all the bankers’ fault” would imply.
@Greg
“I think you’ll find that in Guernsey you have to be licensed to give financial advice. I presume it is the same in IOM and Jersey.”
A reasonable enough presumption to make and another indicator of the contempt shown by the governments of the Crown Dependencies for the rest of the world.
They are prepared to issue licenses to “protect” their own residents — but outside the islands allow island based product providers to promote their products via unlicensed, unqualified, unregulated and uninsured “introducers”.
And then the Isle of Man government allows the nonentity “introducers” to be represented to pensioners as “professional” investment advisors.
Good for business on the Isle of Man, Jersey and Guernsey
Disastrous for elderly people.
I’m not aware of any sub-prime borrowing crisis in the UK? Northern Rock wasn’t brought to it’s knees by the people it leant money to. It failed because it’s business model of lending long and borrowing short relied on access to the wholesale markets. This access suddenly disappeared when the credit crunch started.
Greg
You missed out the other banks from your explanation. And why were Northern Rock having to do so much short-borrowing?
@Million Dollar Babe
I think your days on this blog are numbered. I’m fed up with your crass stupidity. I discussed why we have a horizon with my eight year old the other day and he could work out that it was because the world was round
you apparently cannot
If that is the level of your observational ability, your postings are of no benefit
@Greg
Didn’t you notice the default rate in Northern Rock? Or its 125% mortgages? Do you know anything?
Northern Rock failed because of the quality of its loan book
@Carol Wilcox
Thanks for the advise, I read the Michael Hudson interview and he seems to hit the nail in the head regarding QE.
I still wonder though if QE is for real, or just a threat.
@Carol Wilcox
I enjoy listening to Martin Wolf’s podcasts.
A couple of weeks ago, he made the case that the US would get away with implementing QE. In other words, for him it was a good idea.
Completely, and utterly wrong. I appreciate that you have some knowledge of taxation matters but this does not extend to capital markets.
Northern Rock failed because the short term money markets froze. No institution could borrow because no institution would lend. It didn’t matter that Northern Rock had a lower quality lending book than say (for example) Yorkshire building society. Neither could borrow, because no one could borrow.
Northern Rock failed because it was unable to repay borrowings made from the money markets with further borrowings. It did not fail because of a huge number of defaults. It failed because of its business model, because it wanted to lend a huge amount more than it’s deposit base.
RBS and HBOS were involved in huge reckless corporate lending. Plus RBS (the worst culprit) had agreed to pay a criminally high price for ABN Amro, which is really what took it over the edge. Virtually every bad deal you hear of these days has RBS’s paws all over it (Liverpool FC for example…although they seems to have got their money back on this one!)
Barclays would have been in a very similar situation as RBS if it had won the battle with RBS (and Fortis) for ABN Amro, but it “luckily” escaped. Their main problem was over exposure to the CMO market (but not UK mortgages).
I know very little about Allied Irish, although I imagine the Irish housing market is not big enough to alone have caused the problems at this bank.
And in answer to your second question, Northern Rock had to do a great amount of short term borrowing because that was it’s business model. In the old days, a building society would lend its deposit book to home buyers. Northern Rock was borrowing money short term to allow it to sell even more mortgages. This short term debt had to be continually rolled over with more short term debt. Unfortunately, as the credit crunch started, Northern Rock were unable to roll over these short term loans. That is what caused them to fail. It was not defaults on mortgages.
@ PSG, are UK domiciled funds (and EU funds) banned from using unlicensed introducers?