Michael Novak’s Shoddy Economic Analysis Part II

Michael Novak’s Shoddy Economic Analysis Part II July 1, 2009

Almost exactly two years ago, when this blog was first launched, and we were all more naive and innocent (!), I wrote a post entitled “Michael Novak’s Shoddy Economic Analysis“. I took him to task for misreading the economic data to prove his point, which was that inequality did not increase under the Bush administration. Well, folks, everybody’s favorite Catholic laissez-faire liberal has struck again, and this time he muses on the global financial crisis. In a nutshell, he blames it on the government and on poor people. This is what he says:

“government action was the principal villain in the 2009 debacle. It was the federal government that forced banks to make sub-prime loans to poor families (who were known to be unable to pay their mortgages on a regular basis)….The federal government even guaranteed the work of two huge quasigovernment mortgage companies—Fanny Mae and Freddy Mac—that wrote more than half of all mortgages during the fateful years.”

This is so wrong I don’t even know where to start. Let me talk about the global financial crisis, which started in the US subprime mortgage market and spread across the world. The explanation I will give is conventional wisdom, on which nearly everybody agrees. Some might emphasize some points over others, but there is nothing controversial here.

Let me start with the global savings glut, something Ben Bernanke has been talking about for a long time. Basically, the huge increase in global savings driven by China and the oil exporters pushed long-term interest rates to all-time lows. These savers wanted to recycle their funds into US securities, which fed a credit boom. What is bound to happen? Well, cheap money led to mounting debt, and the result was an asset price boom, particularly notable in the housing market. It fueled an environment in which people thought prices would rise forever, and people could make capital gains forever, and debt went through the roof.  Now — and this happens time and time again — when you get a credit boom, underwriting standards tend to slip. After all, nobody can lose, so while rain on the parade? This was all aided and abetted by a loose monetary policy, which kept rates low at the short end, and encouraged financial institutions to take on greater amounts of risk.

The second angle is the lax regulatory environment. There were many failures here. Mortgage originators could simply wash their hands of risk by selling it on, thus limiting their incentive to actually monitor it. At the same time, CDOs were created by packaging assets of various quality in one jumbo instrument, and this gave the illusion of safety. Nobody really knew where the bodies were buried and the ratings agencies gave their seal of approval, relying on highly dubious statistical models. Regulators were asleep at the wheel, and did not fully understand the complex interconnections among systemically-important financial firms that proved too big to fail (at least without taking the whole financial system down with them). They stood by when leverage went through the roof, and when firms clearly did not have enough capital or liquidity to support their underlying assets. Market discipline simply did not work.

Were Fannie and Freddie responsible? No. The GSEs might have invented securitization, but this was a private sector affair. More than 84 percent of the subprime mortgages in 2006 (the peak year) were issued by private lending institutions. During 2004-06, the subpime years, the share of subprime loans held by the GSEs fell from 48 perecent to 24 percent. A key reason is that the GSEs were subject to tougher regulation than the private sector. This is not to say that the GSEs were entirely blameless — they did ride the surprime wave to a limited extent, but only out of concern that their market share was dropping fast. Like many other institutional investors, they did so by buying securities that they thought were totally safe.

The next point relates to blaming the subprime crisis on lending to the poor. Again, this is totally off. I’ve addressed this before, and will recap briefly. During the peak of the boom, the private sector made 83 percent of the subprime loans to low- and moderate-income borrowers. Many people on the right are blaming the Community Reinvestment Act of 1977, which required banks to lend in the communities they serve. But top economists like Robert Gorden and Janet Yellen have debunked this myth completely. For a start, the timing is off — the CRA comes from 1977, and was actually weakened by the Bush administration during the subprime boom. Also note that the CRA is restricted to banks and thrifts that are federally insured. In fact, only 20-25 percent of subprime loans came from institutions fully under the CRA. And they were well-known for their good behavior– Janet Yellen (president of the San Francisco Federal Reserve) showed that independent mortgage companies made subprime loans at twice the rate of banks and thrifts. The CRA has actually been a force of moderation.

To get back to the start — if anything is to blame for this crisis, it is the culture of greed, the notion that you can make lots of money by taking financial gambles, by creating something out of nothing. As Pope Benedict noted, “We see it now in the collapse of the great banks that money disappears, it’s nothing…Whoever builds his life on this reality, on material things, on success … builds (his house) on sand.” And speaking of “these fundamental errors that have been revealed in the failure of the large American banks” he noted that  “the error at the basis of it is human greed.” Indeed. Too bad Michael Novak refuses to acknowledge such an obvious point.

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  • “This is so wrong I don’t even know where to start.”

    MM,

    MAYBE NOVAK’S ANALYSIS IS WRONG FOR A REASON!!!

    You put forth what appears to me a very sound analysis. It is conventional wisdom, as you call it.

    But ask yourself: WHY does Michael Novak have a need to go against such conventional wisdom? Is he not aware of what you say? I believe it is wise to assume he is aware.

    It seems to me something deeper is going on. The clue lies in a predetermined NARRATIVE that he is trying to promote. The real question is: What is this narrative? This Vision?

    In your earlier post, “The Neocons Strike Back,” I made some comments regarding Neocons and the Middle East.

    http://www.patheos.com/blogs/voxnova/2009/06/29/the-neocons-strike-back/#comment-58650

    Perhaps you would look at Novak’s economic writings and see if there isn’t a similar kind of “lens” at work. The “lens” is the key.

    What is Novak’s narrative? His intention is to influence policy-making and his economic analysis is subordinate to that political end.

    Remember: The narrative is also his Achilles Heel. To defeat his efforts, it is necessary to unmask that narrative.

  • jonathanjones02

    Of course its not just the CRA or Fannie or Freddie, although those deserve a very significant portion of the blame. I seriously doubt you will find anyone only blaming those two, although its a fun strawman. And of course greed is a big part of this mess – on the part of the banks, looking to grow bigger, on the part of the lenders, who made out like a bandit for a while, on the part of the borrowers, many of whom should have been nowhere near credit. And of course securitizing like that was dangerous (especially after the buyers realized so many loans could not be paid back.)

    The federal government has their hands all over this. All over it, with many partners, quite a few of them happy to line their pockets in cooperation with the government as all sung an “opportunity” and “diversity” is great tune, a mess for the taxpayers to clean up.

    Remember W. Bush’s 2002 addresses to increase minority homeownership? Remember the massive lowering of credit standards? Remember the many other initatives along these lines, starting with Clinton and the Boston Fed study and still continuing?

    So many examples….

    “Pressuring nonbank lenders to make more loans to poor minorities didn’t stop … If it didn’t happen, Clinton officials warned, they’d seek to extend [Community Reinvestment Act] regulations to all mortgage makers. … To rebuff the criticism, the Mortgage Bankers Association (MBA) shocked the financial world by signing a 1994 agreement with the Department of Housing and Urban Development (HUD), pledging to increase lending to minorities and join in new efforts to rewrite lending standards. The first MBA member to sign up: Countrywide Financial, the mortgage firm that would be at the core of the subprime meltdown.

    http://www.city-journal.org/2009/19_2_homeownership.html

    Suggest Malanga or Sailer or Novak or whomever are racist all you want, but there are a lot of details and facts to support the thesis of what is starting to be called the “Diversity Recession.”

    Can you find any factual or analytical detail incorrect, for example, in these nine articles? Anything? There’s a lot of detail, and more emerging all the time.

    http://isteve.blogspot.com/2009/06/mr-ritholtz-has-question.html

    Too little regulation? How about the wrong sorts of regulations!! Errors on the side of too much credit, too much risk, with government encouragment direct and indirect all the way down for decades. The federal government, once again, is knee deep in this. And its starting up all over again. And taxpayers of all backgrounds are the ones getting hurt.

  • wj

    An anecdote intended to support Gerald L. Campbell’s suggestion:

    A few months ago I was talking with a highly regarded Catholic law professor about the tensions between the anthropological principles behind Catholic Social Thought and those that encoded by American Constitutional Law. In the course of discussing varying attempts to explode or cover over these tensions, I made the bland statement that one problem I had with neoconservative Catholics was their claim that the moral problems in American liberalism can be attributed to the 60s, “judicial activism,” and the decline of “traditional” beliefs, rather than interpreting these events themselves as tracing out the logic of liberalism as it develops over time.

    I will never forget what this scholar said to me: “Yes, yes, you’re right here–but to understand these folk you have to look at their funding; who is paying them to say the things they say, and why?”

    I frankly couldn’t believe how forthrightly this man was accusing at least *some* neoconservative Catholics as operating more or less *consciously* in bad faith, for reasons of financial gain or political ideology. That he was so cavalier about this–*of course* these people are mere mouthpieces for their funders, he seemed to say–I found very disturbing.

    I still think the charitable reading of someone like Novak must be to interpret him as arguing in good faith for a set of claims that are mistaken, but it is instructive to know that at least one orthodox, conservative, Catholic legal scholar has no trouble dismissing *some* prominent neoconservative Catholics
    as ideologists, pure and simple.

  • M.Z.

    Tell you what Jonathan. Barry Ritholtz has offered a $100,000 challenge to anyone that wants to debate him over the CRA. Perhaps you could find funding for your half of the bet. The CRA meme is ridiculous and those that continue to peddle it should be ridiculed.

    http://www.ritholtz.com/blog/2009/06/100000-cra-challenge/

  • Barbara Huet de Guerville

    A review of Michael Novak’s book in answer to the New Atheism is online at the New Oxford Review. Pretty appalling stuff.
    Thanks for bringing his economic “narrative” to light. After reading the review his economic views don’t surprise me but I have to say that there are many neoconservatives with a more educated grasp of economics.

  • Gabriel Austin

    I suppose I am quite old-fashioned not to realize who seriously some people take Michael Novak’s writing. My chief “encounter” with Mr. Novak’s screeds are the prefaces he wrote to various volumes in Chesterton’s COLLECTED WORKS. He cheerily contradicts GKC’s thoughts and criticisms of Industrial Capitalism with “he didn’t really mean that”.
    This led me to suggest that buyers of the Collected Works should simply tear out the prefaces so’s not to be distracted by the chaotic high-school ramblings of a second rate mind.

    • Gabriel

      We agree with the annoyance of finding Novak’s texts in the Chesterton volumes. I was extremely disgusted by it; and you note how he perverts Chesterton well, so you can imagine how he has dealt with modern encyclicals (he tried to suggest he helped inspire JPII’s works, if I remember one text I read about 6 years ago). And people do take him seriously, otherwise he wouldn’t be treated as a welcome voice in many areas.

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