History News Network puts current events into historical perspective. Subscribe to our newsletter for new perspectives on the ways history continues to resonate in the present. Explore our archive of thousands of original op-eds and curated stories from around the web. Join us to learn more about the past, now.
I was born in 1957, the same year Milton Friedman came out with The Theory of the Consumption Function, so I thought I'd run a personal experiment to determine the validity of the Life Cycle-Permanent Income Hypothesis. So far, so good.
"Maybe I'm more aware because my wife and I had $70,000 in credit card debt at the time we purchased our house in 1989."
Heavens alive! And you seem so sensible!
You must be one of those libertarians.
As much as I want to find a way to blame everything on government, it is possible, just possible, that some of the sub-prime crisis is the result of people buying stuff they couldn't afford unless everything in their lives went right. I also have a theory that some people underestimate the time it takes to complete a project.
Naturally, none of the causes of the sub-prime crisis should be viewed in isolation: this isn't an either/or choice. Here's a decent online article for those who want to investigate further:
http://moneycentral.msn.com/content/Banking/creditcardsmarts/P74808.asp
Needless to say, sub-prime borrowers are going to be at the top of the scale on balances, and some of the data is from 2001, before recession. Also keep in mind the non-deductibility of credit card interest.
Maybe I'm more aware because my wife and I had $70,000 in credit card debt at the time we purchased our house in 1989. Ah, the good old days!
It seems counterintuitive to me that credit card payments had more impact than the Fed's monetary policy.
But let's think on the margin here. Even if regulation bumped the minimum from say 2% to 3 or 4%, which matches the article's use of 50 or 100% increase, how much is this in real terms on the margin?
With $10,000 in credit card debt, we are talking $100 to $200 a month.
I have no idea what the average balances are of folks who had sub-prime mortgages, but I'd sure like to see that data before I make any conclusion about the likely size of the effect of the marginal change in minimum payments. No doubt it had *some* effect, but whether it really contributed to being unable to make mortgage payments is less clear without some measure of the absolute size of the change.
Using those "50% to 100%" numbers is a classic bit of rhetoric that I teach my first-year students to interrogate - what's the absolute size of the change? That's the information that the article doesn't give us.
I wrote another letter to the NYT, this one in response to Krugman's latest screed in today's paper.
He should give his proposal; of course he won't, because he'd be laughed out of town, if not off the op-ed page of the NYT.
How does he get away with his act?
Sen. Schumer, who is the Big Shot on the Senate finance committee, was raving today on CNBC about Paulson's regulation, saying he deserves a "pat on the back." A kick in the pants is more like it.
--
Twice in ten days, Paul Krugman has stated that the banking system collapsed in the Great Depression because of a lack of regulation ("The Dilbert Strategy," March 31). This would be news to the economist who hired him at Princeton and who happens to be an expert on the economic history of that era, Ben Bernanke. What caused the banking system's distress was the existence of state anti-branch banking laws, which were designed to protect local mom-and-pop banks from competition, but which had the disastrous effect of weakening them, preventing them from growing, and denying them access to the capital that would have stemmed bank runs. Between 1931 and 1935, 22 states repealed these laws; it was this, not subsequent regulation, that made the likelihood of such a future catastrophe nil.
Bear Stearns had a concentrated business in mortgage-backed assets that had been profitable but wiped out their equity when it went bad. In this environment no one has the ability and the guts to see if whats left is worth $15 a share, so JP Morgan picks it up for $10.
I agree that it is unlikely that the Fed tracked "the" natural interest rate perfectly during the period at hand. But it could be that the Federal Reserve kept interest rates too high. The slow growth in real output and the slow recovery of employment is consistent with market interest rates being above the natural interest rate. I agree that the performance of money measures only provides limited informations because money demand can change. And, of course, the demand for the particular set of assets measured by the Fed can also change. For example, the impact of sweep accounts on the amount of checkable deposits people prefer to hold at the point when the quantities are reported to the Fed is hardly something I would treat as a constant.
I think there is a kind of market failure involved. Many investors failed to predict the future correctly, resulting in too many resources being devoted to building houses. I don't know how the government could help things much. I see the article as pointing out how the government in fact was pushing in the same direction.
You're correct. As William Stepp noted, 5% was the industry standard for a long time, and then it dropped all the way down to 2%. None of this was mandated by the government: it was just the result of competition in the industry.
The first guidance the OCC ever offered was in January 2003, when it expressed its concern about negative amortization resulting from minimums below the payment needed to cover interest, which could easily occur when the minimum was 2% and the cardholder was given the option of skipping the payment once or twice a year. They were referring to existing industry practices, and while I ought to reread the January 2003 guidance before going out on a limb, I'm pretty sure it made no reference to any prior minimum payment rule, only industry practices. (Anyone who makes the effort to find and read the January 2003 guidance and posts that I'm in error is a very good friend of mine.)
They wanted banks to implement a minimum that would cover interest and reasonable amounts of principal, but banks expressed compassionate concern for their customers that the law could increase bankruptcies substantially, and bank opposition and pleas for delay pretty much continued until the passage of the Bankruptcy Act of 2005 made it much harder to discharge credit card obligations to banks.
Coincidentally, bank opposition to higher minimums ended once obligations to them became harder to discharge in bankruptcy, and some began raising their minimums in the summer of 2005 This led me to mistakenly believe that it was the Bankruptcy Act of 2005 that raised the minimum, when it only provided the incentive for banks to support it and some to voluntarily raise it.
The first required minimum in credit card history resulted from the December 1, 2005 OCC directive. It went into effect in January 2006. Your article, as far as I know, was correct in all its details on this issue.
The Fed has been targeting interest rates for a generation in order to try to maintain full employment and economic growth. Monetary disequilibrium will always occur when there is a discrepancy between the natural rate of interest, which equilibrates the supply and demand for loanable funds (or investible resources, as Roger Garrison would say) and the so-called market rate of interest, targeted by the Fed.
As George Selgin points out in The Theory of Free Banking (p. 105), when the central monetary planners target (or peg) interest rates, for them to hit the equilibrium bulls eye "could only be an incredible, and short lived, stroke of luck." The odds are nil, which means monetary disequilibrium is the order of the day. That is probably even more likely under Bernanke, who evidently wants to hit the panic button when the obnoxious Cramer pounds the table on CNBC, or at the drop of a derivative, or at least a market index.
While falling nominal interest rates during the market's decline earlier in this decade theoretically could have been consistent with the natural rate, this was unlikely. Real interest rates were too low, particularly during the year Greenspan lowered the fed funds rate to one per cent.
http://economistsview.typepad.com/economistsview/2008/03/monetary-policy.html
The demand for present commodities was also outpacing the demand for money, which would have raised the equilibrium rate of interest. A cut in the fed funds rate was therefore more likely
to be too low and therefore disequilibrating, so monetary policy was expansionary.
My understanding is that minimum payments were entirely at the discretion of credit card companies themselves until the COC regulation of December 2005. Anyone know for certain?
The explanation makes sense as far as it goes, but can it account for how other institutions such as Bear Stearns and Merrill Lynch were caught up in the bubble and melt down?
Why did ML create and then eat a boat load of its own toxic waste, as described in gory detail in a front page Wall Street Journal article?
Why did Bear's stock price go from 170 to under 10? For that matter, why did the stocks of Countrywide, New Century, and Thornburg decline so far?
Why did a bunch of hedge funds collapse from making bad bets on some mortgage-related derivatives?
The assumptions their analysts and traders used clearly assumed growth rates that were too high and discount rates that were too low. They thought housing prices would never decline, just like a decade earlier their analysts thought the same about dot.com stocks. See the 73-page report put out by T2 partners in early March, which discusses some of these assumptions and their consequences, although it needed to be supplemented by Austrian business cycle considerations.
(Hey, maybe Jamie Dimon will be really clever and have his analysts and traders do a seminar on ABCT.)
This has calculation problem written all over it, and the proferred explanation--good as a partial explanation of why Jane and Joe Sixpack thougtht they could qualify for a mortgage when they might have thought twice about trying or maybe have been declined in an earlier era, and of why Countrywide and other mortgage originators would have "underwritten" them--doesn't explain why the other institutions came to be affected, in some cases severely.
Yes, as a 30+ year credit card holder and long-time minimum payment tester, I definitely remember when 5% was the standard minimum, and when running balances didn't seem so insane because it wasn't that much higher than inflation and card interest was tax deductible. I also remember until recently the skip-a-payment options that usually came around at least once a year, nearly always around Christmas, until they were outlawed recently.
According to this article, the founder of Providian said sometime after 1990 that cutting mimimum payments from 5 to 2% would stimulate the industry, so evidently they were as high as 5% at one time.
I'm guessing the industry always required some minimum monthly payment.
http://www.pbs.org/wgbh/pages/frontline/shows/credit/more/rise.html
Er, make that interest, not interesting. Some national authority.
The increase in the credit card minimum payment was the second factor Hummel and Henderson mentioned, and you'll notice they cited the single most respect national authority on the subject as their source for that explanation.
Prior to that regulation, credit card companies could also offer payment holidays: typically, they'd let someone skip a month (interesting accumulating, of course). So, typically at least once a year, the minimum payment was 0%.
Were increased from 2 to 4% starting in January 2006. Evidently minimum payments were required before December 2005, though of a smaller amount. I don't know when they were first required.
"We're from the government, and we're here to help." Uh huh.
http://www.consumeraffairs.com/news04/2005/occ_credit_card_minimum.html
Paul Krugman has been bloviating a lot on the real estate and mortgage decline recently in his New York Times column and blog, and in an interview in the current issue of Fortune magazine. In his March 21 column in the NYT, he blamed inadequate supervision of banks--which are about the most regulated institutions on the planet--and claimed that a lack of bank supervision caused the banking meltdown in the early 1930s. I wrote a letter to the NYT (not yet published) in which I pointed out that the banking meltdown in the early 1930s was caused by anti-bank branching laws that denied them the capital to stem bank runs. Canada, I pointed out, had no such restrictions, and had no bank failures. Between 1931 and 1935, 22 states repealed their anti-bank branching laws, so I guess deregulation of sorts actually started under FDR.
If the failure rate of banks has declined to near zero, this is probably the most important, if not the only, reason.
In his Fortune interview, Krugman says the Fed is approaching a zero-interest rate policy, similar to what happened in the early 1930s. I sent a letter a couple days ago pointing out that real interest rates are now negative, whereas in the early 1930s they were at historically high levels, which acted as a drag on investment and economic recovery. (Kenneth Fisher has a good graphic about this in his book The Wall Street Waltz.)
I agree with Tyler Cowen that the calculation problem comes into play here, because on those occasions when the Fed does pursue an expansionary monetary policy, the discount rate used to value the cash flows of assets will be too low, which can lead to their overvaluation and market sector bubbles, which unwind when rates reverse and/or through the operation of other factors.
Don't look for Krugman to stop blaming the free market and start blaming the factors cited by Hummel and Henderson. And above all don't ever look for him to criticize Bernanke, who after all hired him in his present position.