Pols also encouraged loans to deadbeats in an attempt to buy their votes with other people's risk-taking.
Bankers also invented opaque new forms of securities and as usual priced these innovations for the near perfect conditions that attended their creation, instead of the whole-cycle robustness they actually require.
Consumers speculated on houses, including cash out refinancings and loans without amoritization, and lowered their savings rates, to live higher and to make bigger bets on house prices.
Lots of speculators bet that the whole thing would be inflationary and bid commodity prices to unsustainable levels - those prices attracted new supply which eventually reversed those rises. In a few of the stickest cases on the supply end, the high prices had to damp demand first and those peaked the latest (e.g. this year).
The bets of the speculators that it would end in an inflationary manner were in part based on analogies to the 1970s and in part based on their buying Paulean nonsense themselves. They were completely wrong, because the Fed refused to play it according to their inflationary script.
Instead, the Fed left the narrow money supply that it directly controls, completely unchanged from the spring of 2005 to the spring of 2008. There were no additional spendable dollars chasing all the higher prices.
But banks, private ones, acting on their private initiative and not directed by the Fed, in fact fighting its tightening, increased the broader money supply of savings and the like (which are not regulated by the Fed) by $2 trillion, over that period.
Mainstreet then defaulted on debts to those banks to the tune of $1.4 trillion and counting. Stiffed them and walked away, when their various speculations especially on housing did not grow to the sky.
Four different tiers of private economic actors them broke their contracts wholesale - original borrowers, loan originators, insurance underwriters, and investors in those loans - and as each welshed in turn, bucked the collateral up the chain of creditors, to the major national banks.
Who were thereby asked to take the hit for everyone, on those bad debts, which are a manifestation of capital misallocation costs over the cycle.
They proceeded to take between half and two thirds of said hit out of their own resources, soliciting new private money, using their earnings and their capital reserves etc.
In the last 2 months, they reached their capacity to pay without cascading failure, as each additional write off destroyed more value through loss of confidence than it dealt with of the original loan loss problem. Concretely, the rate of interest banks had to pay on their own debts began to exceed those they can charge borrowers, but factors of 2 to 5.
The banks no longer being able to take the remainder of the hit, it falls to their own creditors, which is all of us, in our capacities as bank depositers and as taxpayers funding the FDIC, which guarantees said depositers against loss. The remaining question was not whether we would pay it, but how we would pay it and what would be destroyed in the process.
Intelligent men correctly decided that it would be preferable for everyone, without exception, to save the financial system rather than to destroy it, while paying the remaining losses. Populist ideologues (not Pauleans) intervened and attempted to stop this, in the hopelessly deluded belief that financiers could still someone be made to pay for it all. This raised uncertainty and accelerated the losses, to the point where the authorities decided to override and ignore such considerations and save the banks while allocating the remaining loss to taxpayers. They are now in the process of doing so.
That is what has happened. It is not in dispute.
Your long historical narrative does not mention the hedge funds levered 10:1 to buy the opaque cycle-agnostic securities created by the investment banks using 5:1 leverage which were derived from mortgages that Main Street used to lever home purchases. You make a point of mentioning Main St. as the pivot point with $1.4T in losses. But the 50:1 leverage added by the combination of investment banks and hedge funds is what made those losses fatal to the financial system.
It seems that you want to lay significant blame on the small investor overextended on a house when in fact they added no systemic risk in a properly priced credit system. They also did not break their contracts wholesale, they broke them in relatively small quantities and mostly with reluctance.
The main factor you try to minimize is mispriced credit, the root cause of malinvestment (along with psychology). You say:
But banks, private ones, acting on their private initiative and not directed by the Fed, in fact fighting its tightening, increased the broader money supply of savings and the like (which are not regulated by the Fed) by $2 trillion, over that period.
Can you explain why and how they did that and also why that increased systemic risk or otherwise contributed to the crisis? Thanks, will read your answer tomorrow.
Through all of your good posts, you've finally managed to confuse me. The largest banks to fail or at risk of failure were five investment banks that take no deposits from the public and are not insured by the FDIC or NCUA.
Are you sure this is what you meant to write? It seems to me that by your argument, those institutions should have been allowed to fail, being they do not take public deposits and are not government insured. I am not trying to put words in your mouth, but you have confused me as to which banks you were talking about. Washington Mutual and Wachovia were bought out and didn't fail so us, their creditors, did not have to take a hit. Since I've posted, I'll ask a question that struck me earier.
In several posts you seemed to acknowledge the sanctity of economic freedom over economic security, and rightly so. In one post you even acknowledged there is no economic security. Do I understand you correctly.
If I do, if you value the sanctity of economic freedom over economic security, then how can you support the current efforts by the US government to impose economic security at the expense of economic freedom?
Aren't you being inconsistent or did I misunderstand one of your positions.
My understanding is that you are for the government taking action to use taxpayer dollars to support the financial sector against possible (likely) collapse.
On this thread, my understanding is that you are stating a support for economic freedom and recognize that there is no economic security, and economic freedom should not be subordinated to economic security in any event.
Isn't this inconsistent? Can you please clear up my confusion?
Good explanation. Thank you.