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December 03, 2007

Krugman on the Big Shitpile

Krugman, unsurprisingly, has about the best round-up of the mortgage mess (or, as Atrios is calling it, The Big Shitpile). I'm not going to try and excerpt it, folks should just read the whole column. I will say that Krugman's conclusion, that "market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created," is completely correct, and something we need to think long and hard about.

December 3, 2007 | Permalink


"It's all so complex!" Sounds like Glenn Reynolds' "Plamegate is sooo complicated!" hand-wringing defense.

And yet, in a way, it's all so simple. No matter how "complex" the system is, all the money that went into it will end up in the hands of the ultra-wealthy.

Complex, my ass.

Posted by: scarshapedstar | Dec 3, 2007 12:44:00 PM

In one sense, no, it's not complicated - too much free money led to a relaxing of lending standards, leading rather inevitably to failure to return on investment, followed by tightening. What is new, is the scale, and the response is complicated, and unclear.

Krugman's summary is good enough, though I've seen better; I think his conclusion - anti "financial innovation" is actually an interesting window into Krugman's idiosyncratic views - he's a liberal who doesn't like that things have changed from the liberalism he used to love. Financial innovation is, of course, somewhat necessary; we shouldn't give up the notion that alternative ways of structuring investments may have some use. What should not have happened - the very free money that the Fed under Greenspan inserted into the system - is identifiable, though perhaps not solvable. But innovation? I think it's a mistake to oppose it as an idea.

Posted by: weboy | Dec 3, 2007 12:55:24 PM

Based on weboy's post, this isn't the first financial crisis and nor will it be the last. Basically its a lot of mostly bright people acting stupid because they can't admit they don't fully understand something. My only saving grace is I admit when I don't understand something. I didn't understand the dot com schemes when people were buzzing about them, and I didn't understand this. I am just smart enough to know there is no such thing as something for nothing. And that's what this was all about. I am not sure how complicated it was, but it sure as hell was stupid.

Posted by: akaison | Dec 3, 2007 1:09:08 PM

One solution is that the Fed inflates us out of the mess--such that the prices of houses stay the same while wages and everything else goes up. Bad for the dollar though. But what else is new?

The housing bubble was created by the Feds to keep the economy going after the stock market crash. Arguably, the Iraq War was another convenient boost(why wait through 10 years of a depression--let's just go to war now to stimulate the economy!). Both of those solutions are coming home to roost. Will the Feds create another asset bubble to help us out of this one?

Posted by: Texican | Dec 3, 2007 1:17:30 PM

I dunno if we can blame the fed entirely for the problems in the subprime market.

Seems to me the main problem is that people cannot renegotiate their loans (which would benefit everyone -- bank doesn't have to deal with a default ... and the borrow keeps the home) because the banks don't actually hold the loans!

See, it used to be that people put money in banks which lent the money to other people and you got a share of the interest charged by the bank. Sheeze ... don't they still show It's a Wonderful Life every day from now until 3 days after Christmas?

Nowadays, though, everything has to be an investment, and everybody is keen to have enough money for retirement 'cause all this talk of the Social Security crisis has spooked everyone. And well, there is a supply of capital by people who want to invest (hence a demand for investment vehicles), so people create investments to meet that demand for investment vehicles. First it was the dot.com bubble, then the current crisis.

If people would put money into banks and banks would lend money at reasonable interest rates to people who need it, then everyone would benefit. But nowadays everyone's gotta be an investor, which distorts the markets and you have bubbles here and bubbles there and a lotta gas everywhere.

Meanwhile, the money has ta be goin' somewhere. It ain't as if the money's just disappeared into a black hole. So where, c.f. scarshapedstar's question, is it going?

Posted by: DAS | Dec 3, 2007 1:28:47 PM

I dunno if we can blame the fed entirely for the problems in the subprime market.

Let's be really clear; it's not just the subprime market. That's where a lot of pain is being felt immediately because so many of those folks were sold a bad bill of goods and their resources are thinner, but there's also going to be a lot of pain in the "regular" mortgage market, including a lot of jumbos, as one sees resets of the ARMs that people got into in order not to be left out of the housing market (or for just plain speculative reasons) .

Posted by: paperwight | Dec 3, 2007 1:33:20 PM

Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.

I don't know about anyone else but that sentence scared the crap out of me. If the Chairman of the Fed doesn't understand what's going on then, really, who's minding the effin' store?

Posted by: Roberto Rivera | Dec 3, 2007 1:38:08 PM

I think it is time to be frank about some things. Ezra Klein knows absolutely nothing about the deteriorating credit situation in America. I wonder if he has even ever read a single book on this subject, much less written one. He knows no financial mathematics that would enable a judicious, well-informed opinion on the subject. He has never worked on Wall Street, or even at a job that requires any financial expertise in general. He knows nothing whatsoever about financial innovations that Krugman mentions, such as C.D.O.'s and S.I.V.'s. Why should we pretend that Ezra Klein's opinion on the significance and nature of the country's credit crisis matters? It does not.

Posted by: George | Dec 3, 2007 1:39:05 PM

Massively off topic, but Jon Cohn is a ninja.

Posted by: Petey | Dec 3, 2007 1:57:32 PM

All of that and yet, you're still here George. Do you have a man-crush on Ezra?

Posted by: Steve Balboni | Dec 3, 2007 2:04:16 PM

Aircraft designers, telephone manufacturers, car companies and a myriad other kinds of system-builders have discovered (some of them decades or centuries ago) that you really don't need certain kinds of innovation; in fact, certain kinds of innovation are actively bad.

What kinds? the ones where the system's complexity suddenly exceeds people's cognitive ability. Too many knobs, dials, sliders, or whatever make software, cars, airplanes, mortgages, mortgage-backed securities and so forth unusable. Sure, you can train people and give them tools to help them use ever-more-complex stuff, but that takes a huge investment of time and money, and it may still not work when the shit hits the fan and reflexes take over.

But wait, it gets worse. One crucial way to make money in the financial industry is to be better at figuring out the "real" value of something than are the people you're buying from or selling to. So straightforward, cognitively manageable financial instruments are almost by definition less profitable than complex ones that can only be properly assessed with special tools or after long training. So there's a built-in incentive to create instruments that the innovator understands, and that others think they understand but don't.

From which it is only the tiniest of steps...

Posted by: paul | Dec 3, 2007 2:04:57 PM

in order not to be left out of the housing market (or for just plain speculative reasons) - paperwight

Also in the interests of clarity -- when I referred to demand for investment vehicles, I wasn't talking about people entering into the housing market for speculative reasons ... I was referring to the reason why we have so many mortgage-backed securities (and other odd financial instraments) that are indeed complicating matters.

I still say a lot of problems in our economy are due to the fact that we have umpteen million baby boomers freaking out about retirement and are flooding investment markets with capital and demanding returns. Remember, investment markets are markets like any other and will attempt to meet a demand by supplying that which is demanded (why the Econ 101 crowd so often tends to forget this is and otherwise treats the stock market like it ideally should be a golden egg laying goose, IMHO, odd).

We saw problems with the demand for certain kinds of investments before. In the 1980s and early 1990s, demand for income stocks put pressure on companies to squeeze out profit, e.g. by massive layoffs. In the later 1990s, demand for growth stocks fueled the tech bubble. And more recently demand for other investment vehicles allowed banks and quasi-banks to sell off mortgages, packaged as investments, thus allowing more money to be lent and more homes to be bought (fueling a bubble) but also causing other ripples as well.

Meanwhile, those who really could use capital still can't get access to it. E.g. while tech companies could get access to more capital than they deserved back in the tech bubble, significant sections of our economy were undercapitalized 'cause they were not able to have sexy IPOs.

Until we fix our mindset of having gone into 1920s level craziness about "investments", we really will go back to pre-New-Deal business cycles. And do we want that?

Of course, what's needed then is to, well, bring back the New Deal. People forget how much Social Security really changed what happened to the elderly. And now we are sliding back. And the glimmers of memory of the bad old days have people afraid and it's hurting us by destroying the markets. And meanwhile people still harp on "the Social Security Crisis"?

As Roosevelt would say about that harping -- the only thing we have to fear is fear itself. And we do have to fear fear, 'cause look at what it has done to our economy.

Posted by: DAS | Dec 3, 2007 2:05:06 PM

George: where in Ezra's post did you find Ezra claiming to understand the financial liquidity problem the US (and the world) is facing because of financial investments purchased by folks who didn't understand what they were buying?

I see Ezra agreeing with Krugman that we don't know enough about what this essentially unregulated set of investment instruments really is. That seems completely different than your rant.

BTW: here's some set-your-hair-on-fire words from a former Reagan Admin. Assistant Secretary of the US Treasury for Economic Policy: Impending Destruction of the US Economy.

Posted by: JimPortlandOR | Dec 3, 2007 2:06:25 PM

I thought the proper term is just "Big Shitpile" -- like "Big Oil"?

Posted by: PapaJijo | Dec 3, 2007 2:09:28 PM

I thought everyone pretty much accepted that no one understands the full complexity of the market. If Krugman (and Ezra) are just discovering that, that is troubling, but perhaps not in the way the think it is.

Perhaps some meditations of the probable effects of trying to impose massive beauracratic regulations and top down controls on a super-complex system like the economy may be in order.

Posted by: Dave Justus | Dec 3, 2007 2:27:03 PM

The Iraq war and UHC will be afterthoughts for the election of 2008. "It's the economy, Stupid!" Watch very carefully, this is gonna get ugly & evil.

I don't have a link, but Calculated Risk, including the comments, is the blog to go to for in-depth coverage of mortgage markets. According to what I just read, Hillary is already all over this, with non-negotiable demands made on the Treasury department. 90-day freeze of foreclosures, no ARM resets for five years. (5 years howaboutthat)

It may not be legal, gov't stepping into private contracts need to go court. And there a lot of levels of contracts in securitized mortgage markets.

Posted by: bob mcmanus | Dec 3, 2007 2:38:31 PM

Perhaps some meditations of the probable effects of trying to impose massive beauracratic regulations and top down controls on a super-complex system like the economy may be in order.

Perhaps likewise in order are some meditations on the fact that it has always been the relative transparency of the US securities markets -- a transparency created and enforced by laws and "bureaucratic regulations" -- that has been one of the great incentives to invest in those markets. And it is that lack of transparency here that Krugman and, by extension, Ezra are concerned about.

Posted by: Glenn | Dec 3, 2007 2:40:22 PM

"he has never worked on wall street"

to george
yes, working on wall street certainly qualifies one to develop "judicious and well informed" opinions!

would you be, following the advice, say, of smith barney analysts and economists, who draw their paycheck from... citigroup?
...or guru~economist, abby joseph cohen who never saw the tech decline coming in the early 2000s when her flock lost everything?
or the economic experts who did nothing in the face of irrational exuberance, how many times now, except give irrational encouragement to uninformed investors in tech, reits, real estate, junk bonds, big pharma, bio-tech? (the list goes on with each passing decade)
these are the lessons one learns, working in the heady halls and dining in the executive dining rooms on wall street:
~~ even a broken clock is right twice a day.

~~ the rich get richer and the poor usually dont.

~~ the plight of the poor is hardly of any concern to those on wall street.

Posted by: jacqueline | Dec 3, 2007 2:56:58 PM

"Perhaps some meditations of the probable effects of trying to impose massive beauracratic regulations and top down controls on a super-complex system like the economy may be in order."

I am a cut to the chase kind of guy. So your response to a situation in which our economy is about to take a down turn because of the under regulation of a vital sector is to argue that it was the regulations that did it? Wow. I imagine this might actually work in some circles.

Posted by: akaison | Dec 3, 2007 3:16:49 PM

Just wanted to tweak Ezra's nose a bit -- my rant is based on Juan Cole's great takedown of Jonah Goldberg: http://www.juancole.com/2005/02/jonah-goldberg-embarrasses-himself.html

I like Ezra's blog, and he seems like a good guy, but he does have a funny habit of linking to articles written by folks that actually know the subject at hand -- and then saying ponderous things like "(His) conclusion... is completely correct, and something we need to think long and hard about". Ooooooohkay. Well, I guess that's settled then!

Folks like Ezra and Yglesias love opining about anything and everything that hits their ADD-addled brains. There is nothing really bad about this, but we should take what they say with a grain of salt. When Ezra writes about health-care, I listen carefully. When he writes about other things....not so much.

Posted by: George | Dec 3, 2007 3:26:46 PM

"Meanwhile, those who really could use capital still can't get access to it."

Having spent 11 years meandering around Wall Street (including some time in private equity), it's really hard to accept this at face value. In fact, the main problem is too much capital chasing too few opportunities. Any plausible opportunity now can easily draw a dozen potential funders. I remember a deal where a bunch of guys tried to restart a defunct factory in the middle of nowhere in an industry where they were going to directly compete against billion-dollar incumbents. And that same bunch of guys had bankrupted that very same factory earlier (and caused their bank to lose it's shirt). And the only collateral they had was the near worthless land the factory itself was standing on (again, in the middle of nowhere, you weren't going to build condos on it).

And there were other VCs interested in that hairy, hairy deal. Unbelievable. I wrote "Run like Hell" across the front of the prospectus and handed it to the partners.

Posted by: burritoboy | Dec 3, 2007 4:44:08 PM

In fact, the main problem is too much capital chasing too few opportunities. - burritoboy

At the level of Wall Street I certainly agree with you. When I talk about a lack of capital, I'm referring to small businesses who can't seem to get business loans, etc. Or even people who want mortgages but who, even though they could pay off a regular mortgage, only find shady ARM deals available to them (because the ARMs are more readily bundled into securities?).

What I mean by a lack of access to capital is those who couldn't register on Wall Street or even barely register on Main Street can't get access to capital. Maybe some of that capital could flow to microcredit?

Or, if people have so much money 'round, they could give it to charity? How's about some sort of charitable account whereby you give to charity now and you get something from the gummint later to help you in your retirement (rather than a tax deduction) -- kinda government backed paying it forward?

Posted by: DAS | Dec 3, 2007 5:09:49 PM

What I think is not appreciated by many people is the utter lack of transparency in these securities and the fact that they were as prevalent as they seem to be.

Institutional investors who thought that they were purchasing shares in funds holding investment grade bonds have been shocked to find that they indeed own a part of the big shitpile. These securities all had at least double or single A ratings or could not have been in their portfolios.

Strangely enough, at least in the funds of which I am aware, none of these investors was attempting to hit a home run. Rather, these were investors primarily intersted in capital preservation and income, with thoughts of only modest appreciation. Why, in such circumstances, money managers would opt for the big shitpile will remain an enduring mystery to me.

The banal conclusion -- claims that markets are rational and that the people who run them are logical actors are grossly exagerated.

Posted by: Klein's Tiny Left Nut | Dec 3, 2007 5:19:59 PM


That is really a great point. When you start hearing stories that the people responsible for grading these investments a) have ZERO idea what they are actually worth and b) wouldn't write the grade down even if they did know, it should freak everyone out.

In the grand scheme of things, the subprime market is still relatively small. That is could cause the havoc that it has should at least encourage us take a look.

Posted by: Alex | Dec 3, 2007 6:26:45 PM


I wish I could assure you that this market is relatively small. One of the asset managers that I am dealing with on this problem is one of the top four or five institutional asset managers in the country. I have been through a number of instances of market turbulence in my career, but must admit that I was deeply shaken by the flaws exposed in this instance, particularly because I respected the comapny involved implcitly.

The cncern I think is that no one quite knows the scope of this market -- but my intuitive sense is that it is far broader than most of us have thought to date.

Posted by: Klein's Tiny Left Nut | Dec 3, 2007 11:18:56 PM

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