I would have enjoyed this more if the diavloggers had spent less time on financial porn and more time on policy questions. For example: The current financial market fubar started about one year ago. How is it possible that events that some describe, perhaps hysterically, as taking us to a severe worldwide recession, were not foreseen or even understood by Alan Greenspan, Paul Bernacke, Henry Paulson, the former CEO of Merrill Lynch, the former CEO of Citibank, Robert Rubin, or Bear Stearns? When I say these people didn’t understand the situation, I’m not being rhetorical: a number of these people expressly admitted that they didn’t understand the ramifications of CDOs, CDSs, etc., and Bernacke’s explanation for involving the Fed in the Bear Stearns meltdown was that the consequences to the economy were unforeseeable. Why isn’t the issuance and trade of these arcane instruments regulated? Commercial banks and public company securities are regulated to the nth degree. If investment banks and hedge funds can put the country in a recession, why shouldn’t they be regulated, too? Commercial banks, through their investment bank sister companies, seem to be betting investor money on some of these unregulated deals, plus messing with their balance sheets

Quoting Anyuser: Why isn’t the issuance and trade of these arcane instruments regulated? Commercial banks and public company securities are regulated to the nth degree. If investment banks and hedge funds can put the country in a recession, why shouldn’t they be regulated, too?

Anyuser, I'm glad you weighed in, I was hoping for a more lively discussion related to this diavlog. I think your question here, is a damn good one. I only agree with the first part of the following, though:

McCain comes as close to making sense as anybody when he says screw the dumb banks, and screw the borrowers that took out dumb loans.

Some people did dumb things, some were given loans that the issuer was in a better position than they were to understand was a bad idea, others were plainly duped. I'd rather see the financial institutions take the majority of the damage - people applying for mortgages aren't financial experts, and often aren't accustomed to bargaining on this scale. I was in the refinance market last year and mortgage brokers were pulling tricks like agreeing to issue a fixed-rate loan and then faxing me paperwork for an ARM, for

Quoting AemJeff: Some people did dumb things, some were given loans that the issuer was in a better position than they were to understand was a bad idea, others were plainly duped. I'd rather see the financial institutions take the majority of the damage - people applying for mortgages aren't financial experts, and often aren't accustomed to bargaining on this scale. I was in the refinance market last year and mortgage brokers were pulling tricks like agreeing to issue a fixed-rate loan and then faxing me paperwork for an ARM, for instance. (True story.) These folks have an advantage over consumers, on the whole, because the deals they're arranging are within their area of expertise, while people buying properties may be engaging in a transaction on this scale for the first (or only) time in their lives. Let the bankers worry that if they issue a really bad loan, there's a chance they'll have to eat it. Obviously I'm not talking about marginal cases, but I'm not talking only about clear cases of deceit, either.

It's hard for me to fully agree with you for the following reasons: How do we distinguish between

Anyuser, I'm glad you weighed in, I was hoping for a more lively discussion related to this diavlog.

Damn - no slight intended toward Brendan. I mean I was hoping for a discussion on the merits of this particular diavlog; and Brendan's post was somewhat on the meta side.

I worked in equity research for several Wall St firms in the 90s and earlier this decade (still do on contract, so I probably shouldn't name names, but big names, I assure you). I wasn't deep in the bowels, exactly, but I wasn't in the executive suite, either. Anybody who now says "gee, we didn't see it coming" is just full of it. Me and my colleagues saw it as far back as 2003. We didn't see the exact contours of the crack-up, of course, and being in research we didn't have first-hand knowledge of either the lending or credit derivatives markets. Nevertheless, we saw even then that the subprime/refi freight train and the ABS freight train were headed right for each other. And if us mid-level guys in research understood what was what (in a Rosencranz and Guildernstern fashion), you better believe the suits did too (we were all suits, but you know what I mean). That the guys at the top knew what was happening and did nothing doesn't necessarily mean they're a bunch of crooks--the incentives were what they were, and there was absolutely no upside for any individual (person or institution) to do the right

AemJeff:

... no slight intended toward Brendan.

None taken. I thought I was going to have nothing to say about this diavlog, partly because I feel undereducated in this area, and mostly because Daniel Gross seems to bring about the same level of understanding to macroeconomics that Michael Goldfarb does to foreign policy. (Will no one rid me of these tiresome frat boys?) He did let slip that one moment of clarity, so I couldn't resist dingalinking to that. It's a pity, because Duff really seems to have something to say. Imagine him with Krugman or Reich, if we could ever get either of those guys back. Or anybody else. I nominate Anyuser, if you'll excuse the lame double entendre. On the issues themselves: I am inclined to think that ordinary people getting hustled into bad mortgages deserve a little bit of help. I agree that there are plenty of people out there who were playing the real estate market like it was a short-term investment, and have no sympathy for them, and I agree that it would be impossible to separate these two types. Still, it does seem that some kind of temporary program to help people keep a roof

How do we distinguish between borrowers that deserve a break and those who don't?

I don’t think that defining that particular sieve is a big problem. If a lender didn't follow its own internal procedures (which conformed to contemporary regulation) and/or if the borrower was clearly not a speculator – i.e. they were purchasing a primary residence, those are the criteria I would propose. If a couple of unscrupulous borrowers still get made whole, that’s a small price to pay. What made the environment that produced this debacle unique was the assumption that market values were going to rise, with no end in sight. I think that assumption distorted the judgment of some lenders.

Wishful thinking makes borrowers illiterate.

The lenders are the professionals – plenty of borrowers just don’t have realistic expectations of their ability to shoulder a particular burden. The system, in the judgment of this liberal, ought to balance the scales in such a way that this is acknowledged. However, having defined my caveats to your arguments, I’ll concede that the structural issues are better understood by people other than myself. I’m making what’s ultimately a moral argument.

Quoting bjkeefe: Finally, as much as I'd like to see the erstwhile high-fliers begging on the streets, I can't really fault the government for helping on things like Bear Stearns. There is a real "greater good for the greater number" principle at work here. It'd be irresponsible to let a thirst for vengeance tank the whole economy. As much as I'd like to see the Hamptons and Westport, CT, overrun by mobs with pitchforks and torches, that'd be a counterproductive indulgence that would end up being worse for everybody.

I think that the "greater good for the greater number" principle can be understood differently on various time scales. The short term consequence is just as you describe. In the longer term, putting the fear of God more firmly into the calculations of speculators can only be a good thing.

Quoting AemJeff: I think that the "greater good for the greater number" principle can be understood differently on various time scales. The short term consequence is just as you describe. In the longer term, putting the fear of God more firmly into the calculations of speculators can only be a good thing.

I agree that it's a good thing to put more fear of consequences into the hearts of people who have the potential to cause catastrophe, but isn't it possible to do that after the fact, just by changing the law? I grant that this way, you don't get to punish those responsibility for today's problems, and so you don't have the immediate examples at hand, but wouldn't a clearly stated new set of policies get you almost all of the deterrence you want? And without punishing the whole country in the meantime?

Quoting bjkeefe: I grant that this way, you don't get to punish those responsibility for today's problems, and so you don't have the immediate examples at hand, but wouldn't a clearly stated new set of policies get you almost all of the deterrence you want? And without punishing the whole country in the meantime?

Admittedly, I might be a little irrationally bloodthirsty in this regard. The problem I see is that there generally doesn't seem to be much moral hazard for people playing way out on the cutting edge.

AemJeff:

The problem I see is that there generally doesn't seem to be much moral hazard for people playing way out on the cutting edge.

Yes, I see that as a problem, too, and I do think some of the complex financial instruments that our system permits to be created boil down to little more than Ponzi schemes. On the other hand, there is the argument that making the cost of risk-taking too high stifles innovation. Naively, I'd like to see a set of rules that allow a CEO to try to shoot the moon, but not to be able to do so with a secure golden parachute always available. That is, I'd like to come up with a mechanism to ensure that those making the big bets keep their skin in the game.