How to Shrink Credit for the Poor

Like Bernie Sanders and AOC, Trump wants to fix prices on credit cards.

WSJ editorial. Excerpts:

"Credit-card rates are set by markets. They are based largely on the Federal Reserve’s benchmark interest rate and borrower risk. Restricting rates will limit access to credit for lower-income Americans. That’s what price controls do: They limit supply."

"The average annual percentage rate (APR) rose to 24.9% from 19.3% between 2021 and 2024 as the Fed raised interest rates to control inflation. The average APR has since ticked down to about 23.8% after the Fed cut rates last year."

"Rates on credit cards are higher than on auto and home loans because they aren’t secured by property."

"Those with lower credit scores are charged higher rates to compensate for their greater risk of default. Rising delinquencies have contributed to higher rates. About 12.4% of credit-card balances were severely delinquent in last year’s third quarter, about the same as in the 2008-09 recession."

"Capping rates at 10% would inevitably force issuers to slash rewards and curtail credit. The latter is what happened after Democrats in 2009 restricted the kind of fees that credit cards could charge and when they could raise rates. A paper by the Philadelphia Fed concluded the 2009 law “likely had an adverse effect on non-prime borrowers.”"

"Studies have also found that lenders restricted credit in states like Arkansas and Illinois after they capped interest rates."

[people then] "may turn to payday loans that charge even higher rates." 

Geithner: Glass-Steagall Repeal Didn’t Cause US Crisis

From Newsmax.

"Treasury Secretary Timothy F. Geithner said the repeal of Glass-Steagall, the Depression-era law separating deposit-taking institutions from investment banking, didn’t play “a material role in the causes of our financial crisis.”

“I know that view is not widely accepted in many places,” Geithner said in response to a question after a speech in San Francisco Thursday. Geithner, 50, was president of the Federal Reserve Bank of New York during the 2008 financial crisis and became Treasury secretary the next year under President Barack Obama.

“A huge amount of risk built up outside our banking system, outside the safeguards and protections we put in place in the Great Depression,” Geithner said. “That risk and leverage grew up, built up, very substantially, and when the storm hit it put enormous pressure on a part of the system that provided about half the credit to the American economy. Nothing to do with Glass Steagall.”"

Scott Sumner argues that a tight money policy by the Fed in 2008-09 largely caused the Great Recession

See A boringly conventional contrarian by Scott Sumner.

"In my new book entitled The Money Illusion, I argue that a tight money policy by the Fed in 2008-09 largely caused the Great Recession.  I’d guess that 99% of economists don’t agree with me on that point.  That makes me a contrarian.

But if I am a contrarian, it’s of a type that is quite common throughout history.  Consider:

1. In the 1930s and 1940s, almost all economists believed that the Great Depression was not caused by a tight money policy at the Fed.  In the 1960s, Milton Friedman and Anna Schwartz convinced many economists that an excessively tight money policy was largely to blame for the Depression. By 2002, even Fed officials like Ben Bernanke acknowledged the Fed’s guilt:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

2.  In the 1960s and 1970s, most economists did not blame the Fed for the Great Inflation.  A few decades later, most economists thought the Fed was to blame.  (Ben Bernanke among them.)

3.  In the 2010s, most economists did not blame the Fed for the Great Recession.  Market monetarists did.

What do the first two cases have in common?  In both cases, an economist focusing on interest rates would be unlikely to blame the Fed.  Rates were very low in the 1930s, and hence money did not look tight.  Rates rose sharply in the 1970s, and hence monetary policy did not look expansionary.

So why did economists change their mind?  In both cases, NGDP signaled a problem.  NGDP fell roughly in half during the early 1930s, which sure looks like tight money.  NGDP growth averaged 11% during 1971-81, which sure looks like easy money.

This is why my contrarianism is so boringly conventional.  I’m merely trying to do for the Great Recession what other economists have already done for the Great Depression and the Great Inflation.  I’m attempting to get people to see that a “Great” economic problem, which didn’t look monetary in real time, actually was monetary.  I am trying to get people to believe that money was tight in 2008, even though it didn’t look tight.  I hope to convince people that the huge drop in NGDP growth during 2008-09 is prima facia evidence of an excessively tight monetary policy.  I am trying to get people to see the post-Lehman banking crisis as being caused by falling NGDP, just as the 1930s banking crises were caused by falling NGDP.

In fact, my contrarian take on the Great Recession is so similar to previous reappraisals of the Great Depression and the Great Inflation that I’m tempted to say that it is I that is actually the conventional economist and all those who have not come around to my view are the true contrarians.

It’s a longstanding tradition for economists to initially blame “Great” problems on non-monetary factors, and then later see them as monetary policy failures.  Why stop now? Keep the tradition alive!"

Rising distance between lenders and borrowers, a measure of risk, affected the financial crisis

See Amazing New Facts About the 2007-2009 Global Financial Crisis by John Taylor.

"This week Raghu Rajan spoke at the Hoover Economics Policy Working Group on “Going the Extra Mile: Distant Lending and Credit Cycles” a joint paper João Granja and Christian Leuz. Here is a video of his presentation https://www.hoover.org/events/policy-seminar-raghuram-rajan-1 along with the slides https://www.hoover.org/sites/default/files/going_the_extra_mile.pdf and the paper itself https://www.hoover.org/sites/default/files/going_the_extra_mile_may_3_2021.pdf

Raghu focused on the causes of the Global Financial Crisis of 2007-2009. He brought entirely new data to the question of what caused the crisis. He examined the distance between lender and borrower. Raghu argued that greater distance is a measure of increased risk, holding the technology of making loans, which can provide better information on the probability of repayment, constant. The lower the interest rate–as generated by the federal funds rate which is in turn set by the Fed–the more there is a tendency to go to longer distances and thus increase risks in an effort to preserve profit margins.

Raghu and his colleagues find by this measure that the period leading up to the financial crisis was a period of increased risk taking. A higher federal funds rate set by the Fed would have reduced long distance lending, and thus riskiness of the loans. A higher federal fund rate would have resulted in less risk taking, and would have avoided or at least greatly mitigated the financial pressures which led to the crisis. In this sense, Raghu Rajan argues that a monetary policy closer to what I argued for back in a 2007 paper would have been better.

The following chart of the interest rate illustrates the issue. The chart is from the 2007 paper which I gave at Jackson Hole, “Housing and Monetary Policy,” and published in Housing, Housing Finance, and Monetary Policy, the proceedings of FRB of Kansas City Symposium. I did not use the informative data or the measures that Raghu and his colleagues use now. I simply looked at policy rules and the deviations from the rules. The counterfactual interest rate is what would have been implied by a policy rule. The actual rate is much lower. The conclusion is clear and Raghu’s recent work supports it: a somewhat higher interest rate in 2003-2006 would have been a better approach for the Fed and would have avoided much of the Global Financial Crisis."

 

Clout of Minneapolis Police Union Boss Reflects National Trend

Robert Kroll fought against independent oversight even as he was hauled before disciplinary bodies and courts for alleged abuse of authority

By Douglas Belkin, Kris Maher and Deanna Paul of The WSJ. Excerpts:

"Former mayors and police chiefs say the immense influence of the unions is a key reason attempts to overhaul policing practices, in Minneapolis and elsewhere, have failed. Many cities, lacking cash to boost police salaries, have handed unions authority over everyday functions of police departments, down to how shifts are assigned and overtime is meted out.

Tony Bouza, who led the Minneapolis police department from 1980 to 1989, described his tenure as “a constant and unremitting battle” with the union. “I was never able to fire the alcoholics, psychos and criminals in the ranks,” he said."

"Mr. Rushin’s study last year of about 650 police union contracts found that a majority of them, including the one in Minneapolis, provided an appeals process that could shield officers from reasonable accountability. (Stephen Rushin, an associate law professor at Loyola University Chicago)"

"The power held by union leaders like Mr. Kroll has grown along with the ranks of police departments and their budgets. The war on drugs and the terrorist attacks on Sept. 11, 2001, led to large infusions of cash and personnel to law-enforcement agencies. Four out of five police officers in the country belong to a union, and they have used that base to accrue broad political power through campaign donations to lawmakers, endorsements and frequently by playing conservative state legislatures against progressive city councils, say labor historians, union officials and politicians.

Police unions were nonpartisan into the 1980s but began to gravitate toward the GOP about the same time Republicans started turning against other public-sector unions while refraining from attacking law enforcement. As the GOP portrayed itself as the party of law and order, the relationship with police strengthened, said William P. Jones, professor of history at the University of Minnesota."

"For years, the police union in Minneapolis opposed the civilian review board, say people involved in the process. In a court deposition in the Mahaffy case in 2009, Mr. Kroll said the police department and the city council considered the review board “a monkey on their back that they just can’t seem to shed and they can’t figure out.”

In 2012, the police union successfully lobbied state lawmakers to severely weaken the board’s authority by barring it from making a “finding of fact or determination” about an officer’s conduct following a complaint."

"Between 1995 and 2019, the Minneapolis contract between the police union and the city grew to 128 pages from 40. It now includes more protections such as a two-day waiting period before interviewing officers in investigations of misconduct and other matters; mandatory paid leave for officers involved in critical incidents; and erasing misconduct records when complaints don’t lead to disciplinary action. Union leaders say such provisions ensure accused officers receive due process."

More home buyers getting down payment help from the government, like that which contributed to the Great Recession

See Home Buyers Get Government Help With Down Payments: Share of purchasers drawing on assistance programs across U.S. doubled from 2013 to 2016. Excerpts:

"Those who use down-payment assistance start out with little or no skin in the game. As a result, some economists and analysts worry that buyers have less incentive to keep making payments if times get tough. In recent years, those who used government down-payment assistance for FHA loans were delinquent at a higher rate than those who didn’t, government data show.

“Someone who can’t come up with a down payment is far more likely to be living paycheck to paycheck,” said John Burns, founder of John Burns Real Estate Consulting in Irvine, Calif."

"Many federal, state and local programs operate through housing finance agencies and nonprofits. They vary by region, but typically offer some amount of cash to buyers who qualify and structure it as a second loan. Some forgive it after a period of time while others require repayment. Sometimes, the program provider charges an above-market interest rate on the mortgage to recoup the money put toward the down payment."

"Down-payment assistance funded by sellers became fertile ground for abuse before the housing market collapsed. Sellers routed money to buyers through nonprofits and then tacked the cost onto the purchase price. The federal government has since prohibited the practice.

Still, FHA Commissioner Brian Montgomery, who had the same job during the financial crisis, has been closely watching risks associated with FHA loans. In a report last year, the FHA said it was concerned about government programs that operate on a national level “in ways that generate benefits for the provider,” and “increase costs, but not benefits, to the borrower.”"

Regulators don't need more power to prevent Great Recessions

See Alan Blinder’s Risk-Assessment Approach Is Mistaken. WSJ letter to the editor. 

"Alan S. Blinder and I have the same goal: a more stable financial industry (“Empower Regulators to Stop Risky Financial Business,” op-ed, June 20). Unfortunately, his solution will solve little.

Mr. Blinder proposes equipping regulators—specifically the Financial Stability Oversight Committee (FSOC)—with more power to control risks to the financial system. Experience makes me skeptical. Before the last financial crisis, bank regulators and the Securities and Exchange Commission had plenty of power to stop the increase in leverage occurring among the largest banks, which seriously destabilized the industry. They chose not to. Some now admit they had only a vague notion of the risks, and thus lacked decisiveness.

Mr. Blinder suggests that, as a political appointee, the secretary of the Treasury is reluctant to act. That doesn’t explain the Fed or SEC’s reluctance with banks that were later bailed out. He is also concerned with the FSOC’s confinement to an oversight role. But each FSOC agency has a long track record of authority not exercised in the face of political winds.

A better alternative is requiring systemically important bank companies to hold more equity capital. Ten to 15 cents per dollar of total assets, rather than the three cents they held before the last crisis or the modest six cents they hold today, would be effective. Institutions that hold more investor capital are more stable, less prone to contagion, better able to support borrowers during recessions and, should they fail, less costly to resolve.

The industry claims requiring more capital would push financial activities outside the regulated sphere, such as into hedge funds. Perhaps, but the market appears to know this and requires significantly more capital of them than of regulated banks.

Supervisors have proven no better than bankers at judging risk. Bank capital above current levels won’t end failure or recessions, but it will help keep them from becoming Great Recessions.

Thomas Hoenig
Kansas City, Mo.
Mr. Hoenig is a former president of the Federal Reserve Bank of Kansas City and former vice chairman of the FDIC."

Democrats May Inflate Another Housing Bubble

Subsidies and regulations created the 2008 crisis. Guess what the 2020 candidates are proposing

By Jason L. Riley. Excerpts:

"Peter Wallison, who follows the financial industry at the American Enterprise Institute, has noted that by mid-2008, right before the crisis, 56% of all U.S mortgages were subprime or otherwise risky. Of those, 76% were on the books of government agencies such as Fannie Mae and Freddie Mac . How did we reach that point? At the urging of federal housing regulators, lenders extended credit to people who never would have qualified for loans using traditional criteria. Lending quotas for favored minority groups and low-income applicants were increased by government bureaucrats, and mortgage companies came up with creative ways to meet them.

During the housing boom, the traditional 30-year fixed-rate mortgage became less common, while interest-only and adjustable-rate loans gained popularity. In 2002 less than 10% of new mortgages were interest-only, but that proportion rose to 31% by 2005. Lenders also knew that Fannie Mae was required to buy a certain number of these risky mortgages from banks, which meant that if a borrower defaulted on a loan, it would be Fannie’s problem and not the bank’s. Elizabeth Warren & Co. would have us believe that insufficient regulation of the private sector caused the housing crisis, but the truth is closer to the opposite.

Another pernicious mantra on the left is that loan disparities between blacks and whites are evidence of bias. Yes, studies show that blacks received subprime loans at higher rates than whites. They also show that whites received them at higher rates than Asians, which suggest that something other than racism is at work. Maybe the rate of loan approvals across groups differs because wealth, income and credit histories differ as well, and banks are in the business of reducing the risk of default."

The 2008 Financial Crisis

By Arnold Kling. Excerpts:

"From roughly 1990 to the middle of 2006, the housing market was characterized by the following:

• an environment of low interest rates, both in nominal and real (inflation-adjusted) terms. Low nominal rates create low monthly payments for borrowers. Low real rates raise the value of all durable assets, including housing.
• prices for houses rising as fast as or faster than the overall price level
• an increase in the share of households owning rather than renting
• loosening of mortgage underwriting standards, allowing households with weaker credit histories to qualify for mortgages.
• lower minimum requirements for down payments. A standard requirement of at least ten percent was reduced to three percent and, in some cases, zero. This resulted in a large increase in the share of home purchases made with down payments of five percent or less.
• an increase in the use of new types of mortgages with “negative amortization,” meaning that the outstanding principal balance rises over time.
• an increase in consumers’ borrowing against their houses to finance spending, using home equity loans, second mortgages, and refinancing of existing mortgages with new loans for larger amounts.
• an increase in the proportion of mortgages going to people who were not planning to live in the homes that they purchased. Instead, they were buying them to speculate. 3

These phenomena produced an increase in mortgage debt that far outpaced the rise in income over the same period. The trends accelerated in the three years just prior to the downturn in the second half of 2006."

"Policy failure played a big role in the housing sector. All of the trends listed above were supported by public policy. Because they wanted to see increased home ownership, politicians urged lenders to loosen credit standards. With the Community Reinvestment Act for banks and Affordable Housing Goals for Freddie Mac and Fannie Mae, they spurred traditional mortgage lenders to increase their lending to minority and low-income borrowers. When the crisis hit, politicians blamed lenders for borrowers’ inability to repay, and political pressure exacerbated the credit tightening that subsequently took place"

"There was policy failure in that abuses in the sub-prime mortgage sector were allowed to continue. Ironically, while the safety and soundness of Freddie Mac and Fannie Mae were regulated under the Department of Housing and Urban Development, which had an institutional mission to expand home ownership, consumer protection with regard to mortgages was regulated by the Federal Reserve Board, whose primary institutional missions were monetary policy and bank safety. Though mortgage lenders were setting up borrowers to fail, the Federal Reserve made little or no effort to intervene. Even those policy makers who were concerned about practices in the sub-prime sector believed that, on balance, sub-prime mortgage lending was helping a previously under-served set of households to attain home ownership."

"There was policy failure on the part of bank regulators. Their previous adverse experience was with the Savings and Loan Crisis, in which firms that originated and retained mortgages went bankrupt in large numbers. This caused bank regulators to believe that mortgage securitization, which took risk off the books of depository institutions, would be safer for the financial system. For the purpose of assessing capital requirements for banks, regulators assigned a weight of 100 percent to mortgages originated and held by the bank, but assigned a weight of only 20 percent to the bank’s holdings of mortgage securities issued by Freddie Mac, Fannie Mae, or Ginnie Mae. This meant that banks needed to hold much more capital to hold mortgages than to hold mortgage-related securities; that naturally steered them toward the latter.

In 2001, regulators broadened the low-risk umbrella to include AAA-rated and AA-rated tranches of private-label CDOs. This ruling helped to generate a flood of PLMS, many of them backed by sub-prime mortgage loans.7

By using bond ratings as a key determinant of capital requirements, the regulators effectively put the bond rating agencies at the center of the process of creating private-label CDOs. The rating agencies immediately became subject to both moral hazard and cognitive failure. The moral hazard came from the fact that the rating agencies were paid by the issuers of securities, who wanted the most generous ratings possible, rather than being paid by the regulators, who needed more rigorous ratings. The cognitive failure came from the fact that that models that the rating agencies used gave too little weight to potential scenarios of broad-based declines in house prices. Moreover, the banks that bought the securities were happy to see them rated AAA because the high ratings made the securities eligible for lower capital requirements on the part of the banks. Both sides, therefore, buyers and sellers, had bad incentives.

There was policy failure on the part of Congress. Officials in both the Clinton and Bush Administrations were unhappy with the risk that Freddie Mac and Fannie Mae represented to taxpayers. But Congress balked at any attempt to tighten regulation of the safety and soundness of those firms"

"There was policy failure when Congress passed the Commodity Futures Modernization Act. This legislation specified that derivatives would not be regulated by either of the agencies with the staff most qualified to understand them. Rather than require oversight by the Securities and Exchange Commission or the Commodity Futures Trading Commission (which regulated market-traded derivatives), Congress decreed that the regulator responsible for overseeing each firm would evaluate its derivative position. The logic was that a bank that was using derivatives to hedge other transactions should have its derivative position evaluated in a larger context. But, as it happened, the insurance and bank regulators who ended up with this responsibility were not equipped to see the dangers at firms such as AIG.

There was also policy failure in that officials approved of securitization that transferred risk out of the regulated banking sector. While Federal Reserve Officials were praising the risk management of commercial banks,11risk was accumulating in the shadow banking sector (non-bank institutions in the financial system), including AIG insurance, money market funds, Wall Street firms such as Bear Stearns and Lehman Brothers, and major foreign banks. When problems in the shadow banking sector contributed to the freeze in inter-bank lending and in the market for asset-backed commercial paper, policy makers felt compelled to extend bailouts to satisfy the needs of these non-bank institutions for liquid assets."