Heritage's JD Foster Explains the Credit Crisis

JD Foster, the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at The Heritage Foundation, explains what led to the credit crisis and why it cannot be ignored.

http://www.heritage.org/research/economy/housingandfinancialmarkets/

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[AtlasShruggery]

"I don't worry about the deficit" - Ronald Reagan

"Reagan taught us deficits don't matter" - Dick Cheney

[auditthepolls]

Tht economic bust was caused by the Heritage Foundation. The ideas espoused by it and amplified by the corporate press have been running this country since Reagan got here. Unregulated markets allowed wages to plummet, destroyed the middle class, created a materialistic society, and blew most government funds on debt and the military. Perhaps the one silver lining in this mess is that the Heritage Foundation will finally shut up.

[learninglemur]

The economic bust was caused by the Fed -- they forced interest rates below the natural rate of interest, fueling an unsustainable credit expansion boom that resulted in tremendous malinvestment and overconsumption.

Roger W. Garrison explains how the Fed lost its way in this paper: "Interest-Rate Targeting During the Great Moderation: A Reappraisal".

[averageworkinggal]

The banks held too many tranches which is where their big losses came from.

Their risk models were not realistic for the conditions of the housing bubble and risky mortgages and the default rates were estimated too low.

[leebertarian]

But the reason the AAA rated tranches fell apart at Merrill, UBS & Citi is b/c of fraudulent misrepresentation of the actual risk, so Moodys & S&P obligingly rated the tranches all AAA. Wachovia & JP Morgan Chase have been sifting through these CDOs -- the bottom tranches are already full losses, of mezzanine defaults only 5% are recoverable and defaults in the senior tranches are only 35% recoverable. Out of $450b it appears that $300b are lost from all three tranches (around 5/8ths).

[averageworkinggal]

It wasn't CDSs that brought down the I-banks.

It was the fact that they held onto the senior tranches in their CDOs and failed to sell the risk via CDS because they miscalculated risk and thought there would never be enough defaults to put the traches that they held at risk.

They were wrong and that is where they took the losses that killed their balance sheets.

So it wasn't 'casino capitalism' that killed the I-banks.

It was incompetent risk management.

CDSs are the kook left's delusions.

[LoneOarman]

He omitted the fact that sub-prime loans were insured in order to get a higher rating to make them marketable; and insured again by speculators that did not even own the investment. Unregulated and perfectly legal insurance fraud (misrepresentation and casino gambing/speculation). Betting is for smalltimers & losers... CREDIT DEFAULT SWAPS are for the real high rollers! The game if often rigged...

[learninglemur]

One of the best general articles that accurately explains the economic crisis in essential terms is: "The Crisis in 10 Points" by Robert Stewart.

[averageworkinggal]

The root cause is a speculative real estate bubble since 1995 caused by 2 main factors: moral hazard created by governmental 'affordable housing' and 'greater homeownership' ideology coupled with extended governmental loose monetary policy that pumped up a massive real estate bubble. The affordable housing ideology's loose lending standards (subprime) popped the bubble through high default rates. The deflation of the bubble is crushing the holders of the mortgage debt.

[chasna2]

Isn't there anybody at the Heritage Foundation that understands economics? It's call quantitative easing and it targets, not the interbank rate, but the actual quantity of excess reserves held by banks. The object is to force banks to go long on Treasuries and flatten the yield curve. It may work to reduce risk, maybe.