The Financial Innovation That Wasn’t.
I need to set up the urgency over the past two years to get the mortgage-backed security refinancing question just right. So I’m going to start with two long blockquotes (forgive me) from Lewis Ranieri, who created the mortgage-backed security in the 1980s. In 2004 Newsweek gave him the title of one of the greatest innovators of the past 75 years. (Awards that year for top historical innovators included James Watson, Frank Lloyd Wright, and Jonas Salk. Mortgages bonds right up there with the cure for Polio – bet someone is regretting that call.)
It is April 2007. Everyone is starting to think there’s going to be a problem with subprime loans. The smartest people realize that traditionally mortgages could be written down easily by intermediaries on the ground – someone at your local bank who you could shake hands with – but that the mortgages packed into sieves of bonds held internationally couldn’t easily be modified. Here’s Lewis Ranieri speaking at the Milken Institute Conference on financial innovation:
the real dilemma for me and I think the real issue . . . will be, we’ve never had to do substantial restructurings in housing in mortgage securities…
One of the accountants – you know, it will not be unusual, in some of these pools to have to restructure a third or more of the pool and we only have four [big accounting] firms and we had three of them in the room and one of them raised his hand and said, well you can’t do that. If you restructure that many loans, you’re going to taint the Q election and FAS 140 and what he was basically saying in English for the rest of [us] poor fools, was that there is a presumption when you – when a bank sells loans, into a securitization that it sold the loans . . . And what he was saying is wait a minute, if you guys can restructure all these loans without going back to bondholder, you obviously have control and you’ve just tainted 140 and Q election…
Well, wait a minute; we have to restructure the loans. The worst thing you can think of is freezing the pool and not being able to do what we need to do and I don’t know how long it would take us. I mean, you know you’ve just basically told us we now have a problem that we don’t quite exactly know how we’re going to fix – and another example of how crazy we can get is, when we restructured mortgage loans, in the past and we’ve done this many times, we actually really know what to do.
We restructured the loans and it was always better to negotiate around the borrower, assuming there was a borrower and for purposes of this conversation, we’re talking about homeowners, not speculative buyers, flipper and all the other guys playing games; we’re talking about people who bought a home and live in it and we, historically, structured those loans. We never send out a 1099.
We basically assume that was a renegotiation, end of story because it was in our best interest, as the lender, to do that but in a mortgage security, you don’t have that freedom because you’ve got get the outside accountants to sign off and the outside lawyers and the outside accountants and lawyers said, time out and I volunteered and said, well, wait a minute. I’ve been doing it this way all along and one of my friends [who is] now running one of the best of the combat servicing operations says, well, I’m doing that now, too and we were told, well you’re doing it wrong. You’ve got to send out a 1099.
That’s an incredibly dopey idea. We’re restructuring a loan around a borrower; he can’t afford the loan and now we’re going to take the NPV of the change and send him a tax bill so the IRS can chase him . . .?
Jump forward 1 year. May 2008. Milken Institute Conference on financial innovation. Here is Lewis Ranieri with the same worry, however he believes we will be able to “innovate” our way out of it. Video from Mark Thoma’s page, my transcript (“…” indicates skipping on my part):
[24m19s] Moderator: Lou, how do we use financial innovation to go forward?…How bad do you think the markets could become if we get mired in a fear of using financial innovation?
Lewis Ranieri: Mortgages are real estate and all real estate is essentially local. The cardinal principle in the mortgage crisis is a very old one. You are almost always better off restructuring a loan in a crisis with a borrower than going to a foreclosure. In the past that was never at issue because the loan was always in the hands of someone acting as a fudiciary. The bank, or someone like a bank owned them, and they always exercised their best judgement and their interest. The problem now with the size of securitization and so many loans are not in the hands of a portfolio lender but in a security where structurally nobody is acting as the fiduciary. And part of our dilemma here is “who is going to make the decision on how to restructure around a credible borrower and is anybody paying that person to make that decision?” And what we need here is financial innovation in the first instance because you can’t do this loan by loan, you are going to have to scale this up to a bigger level and we are going to … have to cut the gordian knot of the securitization of these loans because otherwise if we keep letting these things go into foreclosure it’s a feedback loop where it will ultimately crush the consumer economy
Moderator: How optimistic are you Lou? You used crisis, you used Great Depression a few minutes ago. That’s a little strong…
Lou: It’s not strong. I believe we know what to do because it is not remarkably different than what we’ve done in the past in the context of the housing bubble. if we are allowed to do it. We know how to restructure loans. The process has not changed and technology has made it easier….it will work because of the financial technology and internet technology…I don’t think this is an issue of the government, in fact we’d be better left to do what it is we actually know how to do, we know how to deal with housing crisis…but the difference between a foreclosure and a restructuring is frequently over 30%and because of the feedbackloop that foreclosures create you keep taking a 30% loss on a smaller number. It doesn’t get to be fun. So no this isn’t a government issue, it is something the market needs to do…
And now it is end of July 2009.
(source)
Where’s that innovation that will restructure the loans without needing foreclosures? The one thing we needed them to innovate, the one thing!, and they couldn’t pull it off. If it was a sneaky way to get 40-to-1 leverage, sure. Sell retail consumers put options hidden as bonds, all over it. Take care of the one information asymmetry in their instrument, nope. Nothing.
Instead we get this:
Many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans.
Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue — fees for insurance, appraisals, title searches and legal services.
Recall Lewis’ one problem for financial innovation to solve a year ago: “who is going to make the decision on how to restructure around a credible borrower and is anybody paying that person to make that decision?” Now notice that the solution we have in place, this innovation, is completely backwards. Someone is paying a person to not restructure loans. Lewis knew back in 2007 that this cycle would be incredibly destructive, and in 2008 look the world in the eye and said government intervention was not needed since the innovation was on the way.
Not only is it not here as they wanted, the exact opposite of it is here. Instead of incentives that line up with the investors, or even the households, the quants ended up with someone who makes the most money when both parties suffer. The one financial innovation that could have helped, finding a way to mass refinance failing mortgages, the one financial innovation people were calling for 2 years ago, hasn’t arrived, and I’m tired of waiting for a financial Godot. They have failed, the problem is growing, and the government needs to step in. Dean Baker’s Right-To-Rent should be a serious policy consideration, and I will give it coverage next week. I encourage you to do the same.
Thursday Links
I follow up on Taunter’s excellent post on rescission over at The Atlantic. It’s a ramble that I had fun with, about zombies and end of the world trades and credit cards and how if rescission happened to credit cards, and the same dynamic does if you squint, the government would be all over it.
Free Exchange has an interview with Felix Salmon; especially interesting re: financial innovation.
Jon Stokes has one of the better takes on High Frequency Trading I’ve seen, focusing on the technology side. Not overwhelming, but comfortable enough with the material to really explain a lot of the details. Stokes also, in a follow-up note at Felix’s, points that once again we have a situation where the math and finance (and especially in this case, IT) people are overestimating what each other actually does. Didn’t we just do that?
Paul Wilmott on HFT. Wilmott is a quant’s quant, and is very much at the center of mathematical finance; if there are secret worries about the whole project, they almost certainly get bounced off Wilmott in private – I’ve read that several times trying to figure out how much specifics he knows to worry about without being able to tell.
(h/t Ezra) Sorry I’ve been light blogging this week. I’ve been becoming one with my company.
My theory: Weezer fell apart because Matt Sharp left the band after Pinkerton. All this Rivers focus is misguided. To note, Matt Sharp with Tegan and Sara, covering “Tired of Sex”:
Wallison and Rational Betting
Peter Wallison responds to the defense of the Consumer Financial Protection Agency by Elizabeth Warren over at the BaselineScenario. Here is Wallison:
The irony here is that Warren is not herself perceptive enough to understand what the consumers who took the subprime mortgages actually understood. She assumes they were cheated or manipulated into taking a subprime mortgage. Let’s look at what really happened…
Now, why would a consumer take a “subprime” mortgage when he or she is eligible for a prime mortgage? For one thing, when the home was bought, probably some time between 2003 and 2007, the consumer knew perfectly well that home prices were rising, and that the home was likely to be worth a good deal more a year later than it was worth at the time of purchase. That would mean that even if there was a low or no downpayment the purchaser would soon have equity in the home simply from price appreciation over time…
In addition, the consumer knows what he is earning currently, and—assuming that the economy continues to grow—what he is likely to be earning in the future as his skills and seniority increase. He can then estimate pretty well what would be a comfortable monthly payment. Oddly enough, if the consumer takes a subprime mortgage—one with a low or no downpayment and perhaps a low adjustable rate—he can afford a larger house in a better neighborhood, perhaps even near better schools, for the same monthly payment that he would be required to make for the prime loan.
So, our hypothetical consumer was not being cheated—as the Left would like to believe—but in many (and probably most) cases made rational choices based on what was known at the time.
A few things. I’ve been meaning to link to The 10 Myths about the Subprime Crisis, because I think it is almost perfect (I’ll discuss it later). One myth is the idea of the “low adjustable rate” – in general the option-ARMs had higher rates than the equivalent prime rate. But Wallison makes a good point – people will adjust their risk profile to account for their information on how they are going to do. I might just juggle hacky-sacks and someon else might juggle chainsaws; you can tell we are both equally matched to our comfort level because we’ll drop something at the same rate. Wallison says it is the same thing with subprime mortgages; it attracted those best suited to handle them.
In that same way, since consumers that have better fundamentals choose to take on more risk, it’s a simple statistical test to confirm this hypothesis by seeing that the default rates for subprime loans are the same as the default rates for prime loans:
Oh wait, that’s completely wrong.
Wallison is on to something though. Subprime loans allow people to bet on housing prices rising. But whom? Consumers could always bet on housing with prime loans, indeed by definition they are, since they are making an investment in a home. But the interesting part about subprime loans, something we’ve tried to convey here, is that they allow banks to bet as well.
If you take out a loan on a house, and the value of the house doubles, you are really happy. But you don’t pay the bank any more money on your mortgage. The upside is capped for the bank; they have no exposure (or delta, if you will) to the price of the house. They have secondary exposures to the house price; if your house price goes up you are less likely to default, and if you do the recovery is worth more. But these are secondary things conditional on your actions; they aren’t the real money from the rise, or the bubble.
With subprime, by forcing a refinancing with significant prepayment penalties after 2 years, the bank can bet on the house price rising enough to cover those penalties. I walk through this scenario here. If house prices are going to rise 5%, the penalties eat up 3-4%, and the household gets a little left over. The bank is, in effect, hiring someone to sit in a house they couldn’t otherwise afford. Do we want banks to do this, rampant real-estate speculation? No. We want banks to be banks.
At The Atlantic: HFT
I have a writeup of some of the issues surrounding High Frequency Trading over at The Atlantic Business. The issue can get mind-numbing technical for a general audience, so I tried to convey the Economic 101 issues at play here, and how they effect both the market and other investors. There’s a lot of uncertainty of the effect of this on the market itself; at the very least we should get an SEC investigation.
From this point forward I’ll be contributing material to The Atlantic’s Business website. The ghost of Oliver Wendell Holmes Sr. sleeps well tonight. I’ll still be blogging here regularly, so don’t delete your rss feed or anything, and anything I write for them I’ll throw a note up here with a link. I hope you all follow through and check it out, and link and comment away. (Obviously you should be reading The Atlantic more generally, which has someone threaded the needle of staying a great magazine as well as a must-read website over the past decade.) And at this point I’d also like to throw a shout-out to the readers, commenters, etc. that have grown around this site. One of the amazing parts of the internet is when you get to interact with sharp minds who want to contribute to the ideas you are building – and that has definitely made this all worthwhile.
Schulz’s Protecting Consumers From Consumer Protection
Nick Schulz, who I’ve had the pleasure to have a few email exchanges with, steps into the anti-Consumer Protection arena with Protecting Consumers Against Another Failure of Government. He tries to find ways that the government can step out of the financial protection business to help even things up for them. I think he’s wrong here, but it is a good faith try. Two things of note:
For starters, Congress should support counter-cyclical loan-to-value ratios — that is, more stringent loan requirements during boom times and relaxed requirements in down times. This will be difficult for Congress because it means making the purchase of a home more difficult at times…
Last, the government needs to bury forever the government-sponsored enterprises that helped fuel the boom…To best help consumers, Congress should learn from this mistake by de-politicizing the housing market, starting with Fannie and Freddie.
So having Congress try and go counter-cyclical with minimum housing requirements would politicalize the mortgage process beyond anything Fannie and Freddie have done. Indeed I’m not sure how Congress would do this. Beyond all the hype about the government loosening standards, the only weapon in the arsenal without getting new powers is the definition of the conforming loan that Fannie/Freddie uses, and trying to get Congress to spin that counter-cyclically strikes me as asking for a disaster.
If he’s just concerned about LTV, the interest rate takes care of that by itself. In boom (bust) times, as the interest rate goes up (down), the NPV of a loan goes down (up); this encourages borrowers to either decrease (increase) the principal by paying more down payment or taking a smaller loan out (the opposite of that), making the LTV go down (up). The market is already on the case.
Should the terms of a vanilla loan adjust with the business cycle? No. The vanilla loan should serve as a floor of consumer protection, not as a means of trying to adjust the terms of credit lending during a credit cycle.
The three major ratings agencies amount to a government-sponsored cartel. And therein lies the problem: Large institutional investors who are forced by law to rely on the agencies are harmed when there is no competition…But these ratings agencies were the only game in town – large institutional investors could not rely on securities analysis from competitor agencies to make their decisions.
This is a good point, and I’m not sure what should be done about it. Alternatives I’ve heard, from backing out implied ratings information from cds and bond spreads to letting a thousand ratings agencies bloom all have their strengths and weaknesses. One thing that is worth noting is that nobody was unaware of the conflict of the ratings agencies, yet everyone was still taken by surprise. Everyone including international institutional investors, who aren’t subject to US government impositions. Perhaps it was a matter of the instruments in question being too complicated by the underlying mortgages in them.
Now note if we have a vanilla mortgage option, with a few alternative mortgage packages, CDOs could be structured in a way that used these mortgage options as building blocks. “This CDO is 95% vanilla”, is different than “This CDO is 95% prime” – and people would trade accordingly. That vanilla rating would be stamped by lenders under penalty of law. For all the talk about “subprime” it was obviously difficult to tell the actual performance of the mortgages in question, indeed what was even a subprime loan.
This is what Elizabeth Warren was getting at when she said: “While anyone with a bathtub and some chemicals could be a drug manufacturer a century ago, Carpenter points out that drug companies were willing to invest far more in research and development to bring good drugs to the market once FDA regulations drove out bad drugs and useless drugs. Good regulations support product innovation.” There’s an obvious informational asymmetry in underlying products; if we are going to continue to try and structure consumer debt to keep a capital markets banking system alive, having the government work to hurdle this asymmetry strikes me as very important. And providing floors on the quality of loans, with clear signals to buyers of packaged mortgages, may be worthwhile for both consumers of loans and the people who will ultimately end up holding them.
There’s a lot of talk about protecting consumers, but a Consumer Financial Protection Agency also ends up protecting those who end up on the ultimate other end of packaged consumer debt, be it pension funds in Denmark, a school board in Wisconsin, etc. Lord knows those people need protection too, and they may be against any type of innovation if these informational problems aren’t addressed.
Government’s Role in the Housing Bubble
There are many people who see the housing bubble as primarily a government creation. One tool in that argument that the interest rate deduction we give on taxes, where you can write off the interest you pay on your mortgage on taxes, was a culprit. From The Wall Street Journal:
The idea that home ownership confers special benefits on American society is deeply embedded in our culture—so much so that our national tax policy confers a special benefit of its own on it. Home ownership is granted an advantage over all other forms of ownership in the form of an enormous deduction on the interest payments most individuals incur in financing their homes. Nothing else in the tax code comes anywhere near that deduction in scope or size….
After 2000, the national push toward home ownership intensified in three dimensions, leading to a doubling of housing prices in just five years’ time. First, the Federal Reserve Board’s interest-rate policy drove down the cost of borrowing money to unprecedented lows.
John Makin wants to argue that the housing bubble was inflated because the Federal Reserve decreased interest rates, and because we offer a special tax bonus that allows you to deduct the interest you pay from your taxes. I think Arnold Kling has made this argument. So have a lot of other people on both the left and the right. What I want noted is that these run in opposite directions. In so much as the bubble was inflated by lower interest rates, the tax benefit towards interest on housing should have slowed down the housing bubble.
What? How? Very simple. Let’s say it is Scenario A, 2000, and you want to take out a $200,000 mortgage. The yearly average for the 30-year mortgage rate in 2000 is 8.06%. The accountant you are talking to tells you that your monthly payment will be $1,475.
Suddenly you blink, and it is Scenario B; it is 2004, where the yearly average is 5.841% on a 30-year mortgage. Now your accountant tells you your monthly payment will be $1,175. You tell him “I want to keep my monthly mortgage payment at $1,475; how much housing can I get?” (What’s the new NPV?) He clicks excel and tells you $251,019, and you take out that mortgage. You are willing to pay 25.5% more. (The percent numbers are the same regardless of principal amount.)
Now notice something – your monthly payment is just principal towards mortgage and a tax-deductible interest payment. Since you are making the same payment in each payment, and paying off more principal in each payment, you must be paying less interest in each payment. The housing interest deduction was already in your valuation when you originally wanted the $200K mortgage for the interest you were paying in Scenario A. Now you are getting more house but paying less interest – so that deduction is a net loss in the switch between the scenarios.
So taking the difference between the interest paid in the two scenarios, adding them up every 12 months and multiplying by a third to get an approximate tax benefit, and then discounting at the new interest rate (work here, in google spreadsheet), you are now willing to only pay 21.5% more.
The cool thing is that it probably did stoke up people to leverage more between Scenario A or Scenario B, but that requires some sort of bad mental accounting or behavioral financial mismanagement in order to to make the books proper. Mind you, I think there are good reasons to get rid of the interest rate deduction, and I don’t think it would be very harmful for the economy.
To finish the picture, there was also a tax cut during the Clinton years where sales of houses were not taxed as capital gains anymore. Before they could be taxed at up to 20% like stocks, etc. So I add another piece to the NPV calculation, where principal payments are multiplied by 1.2 in every period and discounted, without adjusting the interest. This feels most generous; it wouldn’t necessarily apply this way to everyone, but I want to make the strongest claim – this, with the interest rate deduction, brings us to an overbid of 29.9%
So in hyper-rational perfect strokes from textbook consumers world, the government intervention at best can justify a housing price jump of 30%. According to the latest Case-Schiller city composite 20 is up 106% during the time period in question. We are going to need more than just blaming the government.
Look on my Financial Engineering, ye Mighty.
Felix responds to my previous post about 401(k)s and still believes his “thesis that financial innovation over the past couple of decades has been, on net, a bad thing.” Felix isn’t necessarily looking for a specific instrument that has been good but is making a more general indictment of the financialization of the economy, but I’m going to throw one out. I suppose this depends on where you draw the line, but I’ll suggest the Interest Rate Swap market as a piece of positive financial innovation from the 1980s. Many noise traders have blown up otherwise good portfolios with them no doubt, but on average I think they have been a win, for specific reasons.
As opposed to monstrosities like reverse convertibles, it is very clear what one is getting, and isn’t designed to trick people from their money. It is one item that adjusts one series of cash flows. We have good reason to believe the interest rate yield curve is rationally priced, and with a quick excel check you can figure out a fair value for an interest rate swap. Retail investors should never be allowed near one, of course, but for informed investors they aren’t trying to figure out the likelihood of events deep in the tail like a CDS, or something that is opaque, hidden, and not necessarily subject to arbitrage forces downward, like how housing will do in the next 5 years. They are easy to get out of, and they can actually hedge, or speculate on, a real risk easily. I’d like to see fewer school boards take large positions in this market, but on average I think it has been a win.
Is there anything to salvage in the last 60 years of financial innovation post-crisis? There are three waves of financial innovation:
1950s-1970, Portfolio Selection: This is your CAPM, mean-variance analysis, diversification arguments and index funds. This sets up future stock price movements to be the results of correlations, and where you get your heavy asset allocation statisticians. It is also why when you look at stock information, say at Wolfram Alpha, there’s a mess of correlation charts and data. Beta is more or less dead now, having been performed so hard by market participates that it has lost its ability to predict what it was intended, and is now replaced with factor models and momentum effects.
Asset allocation has taken it on the chin lately but I don’t think it will go away. I don’t have a lot of opinion on equity allocation, not having to deal with it directly, but I’d like to say that we are exposed to a lot of systematic risk in the market lately, and that the theory was exactly that you couldn’t diversify away from this aggregate market risk, just the idiosyncratic risk of individual firms.
1970s: Black-Scholes. Call and put option pricing. Binomial models to supplement Black-Scholes to non-constant volatility and correlation models. I think the bevy of call and put options available on exchanges have been a net win. It gives us more information on the evolution of prices in stock in a medium term period, and allows people to hedge, or speculate, on the evolution of a stock.
1980s-on: Here I’m mostly in agreement with Felix, though I think it is important to view the changes in the context of the larger change towards a capital markets banking system, and the instruments that were needed to start up this system and keep it running after the wave of late 1990s deregulation kicked in. I’m not sure if we can go back easily, though repealing a fair amount of the banking deregulation would be a start.
Financial Innovation Again
What’s the most important financial “innovation” for regular consumers of the past 30 years? It has an obvious answer. No, it is not the ATM machine. I’ll give you the answer in a bit.
Felix and Tyler have a go around over whether or not financial innovation is any good. I seriously dislike the term financial innovation. It obscures the debate more than it clarifies anything. Finance is a way of connecting savings and borrowers, and as such is a system that is influenced by and in turn influences the real economy. It is difficult to separate the financial innovations of the 1970s – interest rate swaps, CBOE, currency swaps – from the collapse of Bretton Woods. It is not the stuff that consumers will see – indeed most of what we are calling innovation at the consumer level is really just a scheme to jack consumers with hidden fees or used as a tax dodge.
Innovation is usually thought of as taking a good or service and making it obviously better – cheaper, more productive, and/or more features. Finance doesn’t necessarily work that way. What are some guidelines for talking about financial innovation?
ATM
The ATM is not a financial innovation. There’s nothing interesting financially about it. As a baseline, a financial innovation has to involve finance. Instead of going to a teller at the bank to take out cash, you can go to a machine next to your restaurant. Financially, there is no difference between that machine and the bank hiring a teller to stand there next to the restaurant. Obviously a bank couldn’t afford that, but it can afford the machine due to breakthroughs in informational technologies. But in terms of cash flows, risks, etc. – the stuff of finance – there’s nothing interesting there. This is different than overdraft protection, or the minimum payment on a credit card, or an interest rate swap, which has actual effects on finance.
Is the subject at hand something a well-informed MBA should know about? Checking your balance or paying your bills online – an MBA shouldn’t be aware of the IT work that goes on into making sure that account information gets passed to your browser correctly; an MBA who will do accounting for a major company should know how an interest rate swap works. The second is financial innovation and the first isn’t. So anything that isn’t primarily about finance shouldn’t be lumped into finance.
Most Important Innovation
Did you figure out what the most important financial innovation for consumers is yet? No, it isn’t credit cards.
It is the 401(k), created in 1980. Some stats: In 1983, 62 percent of workers relied on a defined- benefit plan; by 2007, only 17 percent did, while 63 percent only had a 401(k) or similar defined-contribution plan. Assets in 401(k)s had jumped from $92 billion in 1984 to $3 trillion.
Notice how we normally talk about innovation in other markets doesn’t really apply here, nor does it help us understand what is going on. It’s the creation of a loophole in a tax bill; is the guy who saw this loophole for what it was like Thomas Edison discovering the light bulb? We can change it entirely with another tax bill. Is it an innovation over the pension? It isn’t obviously better than a pension (defined-benefit plan), like the Playstation 2 is obviously better than the Playstation 1.
One story about the rise of the 401(k) is that someone has to hold the risk bag, and instead of employers, or the government, it is going to be consumers. There’s a plus that consumers can directly manage their retirement finances, and a negative that consumers can directly manage their retirement finances. The risks have to go somewhere, and now they are going to be transfered to the individual rather than held at the government or corporate level.
Another story is that the pension system we had in place was workable for the Fordist economy of industrial oligarchies and strong labor unions. We had a system of how the real economy worked, and the financial system stepped up to provide investments regime suitable for it. Even this is a bit of a lie, as the pension system was, like the corporate-provided health care system, a middle-ground stalemate that the United States came to as a result of conflicts between labor and capitalists rather than something we all agreed on. As this system of the real economy was historically contingent, and as global competition kicked in it started to tear at the seams, corporations were no longer going to be strong enough to hold these risks. So the financial system had to evolve accordingly, and it did so by moving it back to the individuals with some weak corporate ties in matching.
Now notice that this has a strong dialectical relationship with the real economy. There are less incentives to stay with a company for 30 years, so workers are going to move company to company more. This will effect our neighborhoods, communities, labor arrangements, etc. There is more of an incentive to earn more money earlier in your life, as to take advantage of compounding interest, rather than later in your life, as your pension is tied to the last 5 years of earnings. This (may, it would be cool to see research on this) leads to workers investing more in labor and competitive education earlier in life, leading to less family formations in one’s 20s. This has real consequences for the economy itself. So it may be better to think of finance less as a light bulb that lasts 20% longer and more of a field that is influenced by, and in turn influences, the real economy.
Elizabeth Warren, live at The Baseline Scenario
Elizabeth Warren has a guest post up At the Baseline Scenario, arguing for the Consumer Financial Products Agency. It’s a really solid post, listing the current wave of complaints against the agency and dismissing them one by one.
I think this kind of interaction bodes well for the future of the blogosphere; the way experts can help set the tone for a topic that has already had a first wave of discussion. If you want to get me a b-day present, link and comment away to that entry – the more I read about it, the more I think this is a good idea, whose critics aren’t passing a good first-approximation argument.
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