Initial Thoughts on the GOP’s FCIC Dissent, “Financial Crisis Primer.”

So the GOP alternative to the Financial Crisis Inquiry Commission report is online: Financial Crisis Primer: Questions and Answers on the causes of the Financial Crisis. It’s signed by Peter Wallison, Keith Hennessey, Bill Thomas and Douglas Holtz-Eakin. Initial reactions:

My academic side: If the four of them brought this to my office hours I’d advise them to take an incomplete for the class and turn in the paper next semester in January. The paper is 9 pages, and about 5,000 words. There are almost no hard numbers. There are only three citations. Everything here was in the popular narrative a year and a half ago.  This was supposed to be original research.

Real talk: If you want a center-right view of the financial collapse and financial reform (mostly reform, but the collapse is implied in there), I’d recommend checking out the The Squam Lake Report, which has Duffie, Rajan, Cochrane and many others (I think it is online as well).  I learned a lot more from engaging with that view of financial reform.  You should note that many of the authors are embedded pretty deep in the financial markets and have huge conflicts, well documented in this fascinating interview with Gerald Epstein about his paper documenting these conflicts (more on that).

So: where to begin with the GOP paper?  In the beginning the GSEs were the primary drivers of a housing bubble, a housing bubble that came about because of U.S. government policy acting as social policy.   The private securitization market was created, in theory, to deal with this demand for housing.  This network had some leverage in it causing a bank run when the bubble collapsed.  The second half is a pretty standard narrative in some ways, so I’m assuming the reason this was released was to make the securitization process look like both a bystander and a victim of an out of control GSEs.

I can’t respond to this argument because there are no numbers or citations. It is likely that Wallison is using Edward Pinto’s idiosyncratic definition of what constitutes a subprime mortgage, renaming prime loans with FICO < 660 as subprime, and not industry standard, as James Kwak has taken apart elsewhere. There’s the normal CRA caused the housing bubble stuff in there which has been debunked. That the GSE kicked off the housing bubble has been taken apart by the GSE’s Conservator’s Report, well reviewed by Karl Smith here. There is no engagement with counter-arguments, no narratives, no facts, no numbers. So there’s simply nothing for me to respond to in this report.

The rest of their narrative is fairly conventional off that baseline.   There’s no mention of derivatives and the role the credit default swap market played in providing insurance for these mortgage bonds.  (Indeed, the word derivative and credit default swap/cds aren’t included at all.)  There’s nothing about the latest research pointing to securitization being a major driver in increasing mortgage debt.

It’s funny that they voted to ban the word shadow banks, because they give an account of it causing the financial crisis:

Runs can be sparked by real losses, but in the end, they are all about the loss of confidence that depositors will get their money back.

Bank runs have not been all that common in recent history because banks facing a run can borrow from the Federal Reserve to meet liquidity needs, and most deposits are insured by the Federal Deposit Insurance Corporation. But other types of financial firms fund themselves using a similar mechanism without the government backstop. They issue short-term debt to investors and pay a small interest payment in return. Investors will usually choose to roll over their loans when they mature, similar to a depositor choosing to keep their money in the bank. But once investors get spooked, and a run begins, there is nothing that a financial firm can do except try to regain the market’s confidence.

Runs are contagious. During a panic, fear of loss spreads quickly. When one firm is failing, investors will often lose confidence in firms with similar business models, or similar asset holdings. This is how the panic spread in the fall of 2008.

I’m not really sure what value this adds.  They had the power of subpoena, staff and a budget, and, random bloggers covering it have done a much better job.  Ezra Klein has more in these two blog posts summarizing Gary Gorton’s work about the nature of these shadow bank runs from a year and a half ago than all the GOP could come up with in a year, and there’s been a lot more written about this topic since then.

(This New York Fed report is where I believe the cutting edge is on shadow bank stories;  have fun zooming in on the shadow-banking map on page three.)

You’ll be happy to know the last line is:  “We caution our nation’s leaders to learn the appropriate lessons from history and take seriously the need to reduce our federal deficit.” I can only assume they ran out of time before explaining why we need to reject the START Treaty and DREAM Act to protect against financial crises as well.

But I have to hand it to them.  They decided to take one for the team and release this report that implies markets can never fail, only governments.   No sources, no numbers, no new info, not even 10 pages, but they put it out there so reporters have the option to go “well, on the other hand the Republicans said this.”  That’s how seriously the conservative movement takes ideological warfare.