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Wednesday, October 01, 2008

Some links on the crisis

Here are some links worth reading concerning the financial crisis:

1. Justin Wolfers, an original signatory of the economists' letter concerning the original Paulson plan, which some have taken to be a compelling argument against the plan defeated Monday. Wolfers writes:

We have failed to explain in clear language just what it is that credit markets do, and hence why it is so important that we fix them. (Dani Rodrik agrees.) This failure is all the greater, given the public’s understandable cynicism about Wall Street, the government, and economics. Our failure helps explain why Congressional populists believe that opposing the rescue plan will help their re-election prospects.

2. David Leonhardt's article in today's NYT. The opening story is a cautionary tale: it concerns former Fed Board member Frederic Mishkin's father and his -- yes, I'll say it -- wrongheaded view that the 1929 crash served the bad guys right. Didn't take long to serve the good guys wrong, as it happened. The rest of the article is also excellent.

3. Tyler Cowen offers a sensible perspective from the right (or wherever it is that Cowen views himself). All of it is good (which is not to say I necessarily agree with all points), but vis-a-vis my earlier posts, I think these two points are of particular note:

10. Libertarians are overrating the moral hazard argument, as many equity holders have been wiped out.

11. If someone is pushing conclusions and not identifying the potential weak points in his or her arguments, be suspicious. Also beware of anyone pretending to offer you simple answers.

On point 11, virtually everyone offering any conclusion has some potential weak points to defend. Mine are: (a) there is no guarantee Monday's bill, or its slight modification, will work, though I'm quite confident that doing nothing will work worse; (b) Monday's bill no doubt involves some risks, including moral hazard ones, though I believe the short-run debt-deflation and adverse selection risks justify taking the moral hazard risk, esp given the second part of Cowen's point 10; (c) as I understand its language, the bill still leaves a lot of stuff up to the Treasury Secretary's discretion (though my understanding is that there is now real oversight built in), whereas I would much prefer to see language mandating the use of mechanisms likely to minimize the costs of providing liquidity and ameliorating balance sheets -- for an example, see this article by my former Maryland colleagues Larry Ausubel and Peter Cramton, who are among the leading auction scholars and designers in the world.

4. Felix Salmon's post from yesterday, The Dysfunctional Credit Market. The post discusses various measures of problems in the credit market, which have been less discussed than the stock markets by many MSM reporters (CBS World News got it right last night, though) and at least some ill-informed blog commentators. Read the whole thing, but here's Salmon's conclusion:

I'm glad that broad stock-market indices are up 4% today. But looking at the credit markets, things are still very bad indeed. Remember, the equity markets have been overoptimistic during the entire history of this crisis. They're not really to be trusted.

5. Focusing only on cost, and not on design, this NYT article, which discusses actions by various European governments to deal with the trouble spreading across the pond from the US. Of particular note:

The Irish plan guarantees bank deposits and debt for customers and creditors of six banks. That makes the government responsible for $400 billion, twice the country’s economic output.

For the record, twice our annual economic output would be $28 trillion; $700b ain't so much when you think about it that way. For a similar example, see this post.

Posted by Jonah Gelbach on October 1, 2008 at 02:38 PM in Current Affairs | Permalink


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This is a question I asked in an earlier post, but I think the blog had moved on. It is similar to what poster johan gelbach is asking above.

This is an issue that my colleagues & I have debated the last several days. I spent some time on Google, but I only found info from over a year ago. Given the fast-moving nature of this, I don't think it trustworthy. Here is my previous post:

I have a question on the mortgage crisis that no one has answered.

Don't people have to buy private mortgage insurance if they have less than 80% equity in their home? So, if they default, doesn't the PMI company pay the mortgage holder. If so, then why are the holders of mortgage-backed securities at risk? It seems that they are being paid by the PMI companies.

Have the PMI companies all gone bankrupt? If so, why haven't we heard anything about that? Are they regular insurance companies that are members of the state insurance guaranty funds?

I'd appreciate any insight you have on this.

Posted by: Texas Lawyer | Oct 2, 2008 2:59:26 AM

Thanks for the discussion (and just to keep the reocrd clear, it wasn't originally my question, but I thought it was an intersting issue).

Posted by: dwk | Oct 1, 2008 4:09:01 PM


i think i was too busy trying to salve various bruised feelings, in what may have been a vain attempt to get people to focus on what matters, to answer your question. sorry about that.

i'm actually not sure what the answer to your specific question is. i've seen surprisingly little (maybe zero?) discussion of pmi in the current situation, and i don't know anything specific about it.

that said, here's some speculation.

first, credit default swap (CDS) securities are basically also insurance, yet many of those securities are or were in trouble (see bailout, AIG on this). so my guess is that part of the problem is that counterparties on the hook for pmi may not be able to make good.

second, i don't know how many now-bad mortgages had pmi.

third, in at least some cases, i believe i read that pmi was essentially just a higher interest rate. in other words, some lenders may have just self-insured, absorbing the risk of defaults themselves in return for a higher rate.

but this is a good question.

Posted by: jonah gelbach | Oct 1, 2008 3:56:58 PM

Jonah: I appreciate your efforts here to explain why the bailout is a lesser evil than letting natural consequences run their course. There was a question in an earlier comment thread about mortgage insurance that I don't think ever got an answer (if it did, I apologize). But if the source of the current crisis is debt held by people who cannot pay their mortgages, shouldn't those peoples' mortgage insurers cover that debt?

Posted by: dwk | Oct 1, 2008 3:35:44 PM

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