Princeton Professor Alan Blinder offers his thoughts in the New York Times on who’s to blame for the mortgage mess, getting the attention of Mark Thoma, Dave Iverson, Brad DeLong, and Greg Mankiw. Here are my two cents.
Blinder explains very nicely why we all should be giving this some thought:
Finger-pointing is often decried both as mean-spirited and as a distraction from the more important task of finding remedies. I beg to differ. Until we diagnose what went wrong with subprime, we cannot even begin to devise policy changes that might protect us from a repeat performance.
Amen to that. So then Blinder begins to tick off his list of folks at whom to point the finger of blame: (1) home buyers who took on mortgages they couldn’t repay; (2) mortgage originators, for issuing same; (3) bank regulators, who didn’t have the inclination or authority to monitor this closely enough; (4) the investors who ultimately provided the funds for the mortgages, and (5) securitization, which led to assets that are “too complex for anyone’s good”. Running out of fingers on one hand, Blinder brings out the dreaded economist’s other hand for (6) ratings agencies which underestimated the risk.
Now, I’m all for two-handed, six-fingered economists, but I really think the big fat finger we should all be focusing on is #4, without which none of the others would have mattered. A dumb borrower requires an even dumber lender. And if there is always an investor to dump the product off on, then of course there is an incentive for someone to originate and then sell off the loan. Evidently securitized tranches is the form in which investors wanted to hold these assets. As for (6), the ratings agencies are only offering investment advice– I see the person who puts up the money as the one who unambiguously must take responsibility for the decision. And how exactly are regulators in a better position to tell an investor that he or she is making a stupid investment, if that is indeed the core problem?
For these reasons, the question I would most like to see answered is, Why did investors buy up this junk? Here is Blinder’s answer:
By now, it is abundantly clear that many investors, swept up in the euphoria of the moment, failed to pay close attention to what they were buying. Why did they behave so foolishly? Part of the answer is that the securities, especially the now-notorious C.D.O.’s, for collateralized debt obligations, were probably too complex for anyone’s good– which points a fifth finger…
In his rush to get on to the next finger, Blinder doesn’t seem to give us a lot to go on with understanding Finger #4, beyond the notion that these instruments were new and complicated and investors were stupid. Stupid, I might add, to the tune of hundreds of billions of dollars.
Perhaps that’s all there will ever prove to be to this story. But I can’t help looking for more, thinking there is likely to be something special that caused the usual incentive structure to break down here, something we might be able to understand with more orthodox economic methodology. In my remarks at Jackson Hole, I suggested an interaction between monetary policy and implicit government guarantees as providing one possible basis for a rational calculation on the part of investors. Jin Cao and Gerhard Illing of the University of Munich have an interesting new research paper spelling out the details of exactly how such an equilibrium might play out. Professor Illing lays out the implications for practical policy-making here.
As I also said in Jackson Hole, I am not sure why investors perceived it to be in their best interests to buy these assets. But I am sure that this is the right question, and would encourage young economic researchers seeking to make a name for themselves to take a swing at it.
Because I basically agree with Blinder– until we know the answer, it’s not clear exactly how to fix the problem.