Inside Financial Services

Misreading The Cause Of The Panic

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Channeling Hyman Minsky (and making no sense whatsoever), long-time bank-basher Peter Eavis seems to think the 2008 panic came about because banks figured out how to skirt the rules laid down by their regulators.

[Minsky] identified and warned about the sort of trends in the financial system and the wider economy that helped cause the last financial crisis. That is why when everything started falling apart in 2008, some commentators said a “Minsky moment” had arrived.

Mr. Minsky pithily observed that stability gives rise to instability. As the economy grows steadily, banks and companies start to overreach. Banks lend too much, and companies and consumers overborrow, which ultimately makes the system fragile. And while financial regulation was necessary to limit excessive behavior during those stable times, Mr. Minsky observed that bankers eventually found ways around the rules. [Emph. added.]

Eavis is badly mistaken. The 2008 crackup didn’t happen because banks “eventually found ways around the rules.” It happened because banks followed the rules too well. In particular, they eagerly complied with regulators’ mandates that subprime mortgage borrowers be given mountains of credit. Once those mortgages turned sour and too many institutions ended up owning more of them than many could bear, things came crashing down. There was a Minsky Moment all right. It occurred when the nationwide housing bubble finally collapsed.

Worse, Eavis’ misreading of how the credit panic happened causes him to another misjudgment: lauding regulators for the opaque approach they’ve taken in judging the living wills and stress tests banks now have to produce as a result of Dodd-Frank. If you don’t give banks explicit rules to go by, he argues, they won’t figure out a way to get around them! Eavis is certainly right about regulators’ opacity. Seven of eight big banks had their living wills either disapproved or heavily criticized last week, and no one seems to quite understand why.

Eavis says this is a plus, but that’s crazy. Regulation by seemingly random fiat isn’t regulation at all, but more like controlled anarchy. It’s costly to banks (and by extension, consumers), and isn’t apt to control risks to the system any better than an organized set of rules and guidelines. Transparency is said to be a virtue where it’s applied to other parts of government, but lack of it is supposed to be a good thing when applied to bank regulation. The logic of that eludes me.

What do you think? Let me know!

8 Responses to “Misreading The Cause Of The Panic”

  1. Avatar Injun Joe

    The Bankers were over-leveraged. That was their sin. The various regulators played a huge role. When they mandated that reserves could not come from historical experience and added mark to market, they made a pro-cyclical feedback loop that turned a lending downtrend into a panic. Otherwise, everything would have been nasty but manageable. In their zeal to hate banks, people like Schumer actually caused a run on Indymac. Then, there was plenty of abuse in the Markit index which allowed short sellers to effectively manipulate the value of asset classes like CMBS.

  2. Avatar SW Pilgrim

    He didn’t read or see The Big Short? Everybody had sticky/stinky fingers°

  3. Avatar Morgan's Mom

    His report and expressions sound like a big government guy. He can trust the government regulators, but not the banks! My opinion, they both need scrutiny. Where is our government’s accountability?????

  4. Avatar etoleary

    By 2008 there was too much leverage most everywhere, period. The immediate cause of the panic was the collapse of Lehman, not a regulated BHC at the time.

    Big Short is entertaining but hardly a definitive diagnostic source of the financial panic. Light touch regulation turned out to be no touch regulation and that was a mistake. There’s plenty of blame for most everyone involved to go around.

  5. Avatar Ringleader

    Let’s not forget the “unregulated”. All those mortgage origination company types, and our own Congress! Legislators got up and pounded the table to “make home ownership accessible to all” and then looked the other way when unregulated originators sold millions a bill of goods on ARM’s, the “certainty” of increasing home values and no doc mortgages. BOOM! Meanwhile, Main Street bankers weren’t even allowed to use the terminology “low rate” when rates were historically low!

  6. Avatar JRG

    ” Regulator mandates that subprime borrowers be given mountains of credit” is a ridiculous comment. There were no mandates. The whole system from originators to the CDO packagers were actively originating loans to feed the process and make money. Underwriting standards continued to be lowered so that volume goals could be met to fill up the MBS and CDOs.

  7. Avatar Andrew

    The Minsky framework is really that lenders and other providers of capital take progressively more risk in seeking returns. Accepting principal and interest in repayment at first, followed by interest only, and finally capital appreciation only or speculation in the end. I have to agree with Tom, regulation as a solution is a joke. There’s a huge revolving door between the public regulatory agencies and private firms. In addition, how come no one goes after the ratings agencies? They were getting paid to rate securities higher than what their fundamentals would really suggest. As Tom notes as the conduit provided by FNMA and FHLMC to mortgage underwriters meant they didn’t have to hold any of the loans on their books… the disentangling of loan underwriting, servicing, and issuer all in the name of “every American should own their own home”….. well…. evidently not. Probably just as disastrous as every American should attend college…. and once again are the bankers holding a gun to anyone’s head and forcing them to borrow money here? Nope. But, they will get demonized int he end as “greedy”. Absurd.

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