Public Policy Press
©Martin Lowy 2009
—INTRODUCTION—
--Leverage is a two-way street.
In September 18, 2008, three days after the investment banking firm Lehman Brothers filed for bankruptcy, President George W. Bush listened as his senior advisers laid out the critical condition of the
Mr. President, we got here because in the apparent boom time, from 2004 to 2006, American people and institutions borrowed too much and spent more than they earned. Mortgage debt created the boom and its implosion created the Crisis. Excessive borrowing always is the cause of a serious economic downturn, and the Crisis of 2007-2009 is no exception.
I bring to this book over 40 years of experience as a lawyer, as an advisor to regulators, as a banker, and as a student of banking history and regulation. My experience covers dealing with failing banks, saving a few banks from failure, and supervising a real estate lending department. I was a securities lawyer as well as a bank regulatory
lawyer. My books include High Rollers: Inside the S&L Debacle and how-to books for directors of banks and public corporations.
In the course of writing this book I have found that, despite so many words already having been written on the subject, many of the hard questions have not been asked very often—and some not at all. The data tends to be used to support pre-conceived positions rather than to answer difficult questions. I have been surprised by how many of my own pre-conceived notions have been challenged by paying attention to the data.
This book has three Parts. Part I, that comprises the first eleven chapters, is a mosaic of the several areas of finance and regulation that we should know if we want to evaluate the many asserted causes of the Crisis. Part I provides you with histories and explanations of topics that include mortgage lending, American subsidies for home ownership, the Federal Reserve Board, financial deregulation, loan securitization, the rating agencies, and the housing bubble of 2004- 2006. Part I answers the question, “How did we get here?” Part I stands on its own as a guide to what you have to know to understand what made the boom years of 2004-2006 and how the bust that followed that boom caused the financial world to fall apart in 2007- 2008.
Part II, called The Bubble Deflates, recounts the major events of 2007-2008 in chronological order. It sketches the history of each of the major American companies that failed and explains why they failed. It places the Government’s actions against the backdrop of usual practices for dealing with failing firms and outlines the Government’s options in each case. Frankly, Part II is easier to read than Part I because it is a set of stories.
Part III, called Taming the Debt Spiral, analyzes the causes of the boom and meltdown and makes suggestions as to how to reshape American capitalism to reduce its manic swings to the upside and depressive swings to the downside. Part III includes a chapter that outlines the various “Alternative Causes” that commentators have
suggested. It is, in effect, a quick survey of the literature.
The later chapters in Part III formulate a set of public policy guidelines for the economic sphere that are based on competitive markets. Subsidizing borrowing, as American laws and regulations do in many ways, I conclude, is procyclical and, in the long run, counterproductive. Excessive credit makes the economy manic on the upside and depressive on the downside. Banks are at the center of this instability because they borrow short and lend long to weaker credits. With modern technology, a capitalist society may not be doomed to repeat this cyclical process into infinity.
The subsidies at issue include tax treatment, subsides for housing, and Government support for banks. Reducing subsidies like these would require a far more informed voting population to overcome the lobbies of the businesses that benefit from the subsidies. That is why Part I of this book is so important.
Public policy is the book’s primary focus. Private parties do much of the lending and borrowing but public policy goals do not influence private parties. Only the market, rules that govern and regulate the market, and incentives that government provides tend to influence private parties participating in a capitalist economy.
INVITATION TO A COMPACT
The world is full of misinformation. It is on the airwaves, in the blogs, in the emails you receive from friends every day. Few of us can separate the wheat from the chaff, so we tend to believe those asserted facts that coincide with our political or ideological predilections. I have tried to overcome that tendency to assimilate only facts that
confirm what I already believe. I ask that you do the same.
When we get to the end of this process, we may find that we have to question some of our assumptions about globalization, about capitalism, about regulation, and about banking. When I began to write this book, I did not expect to have to do that. But I now find that it is necessary. Please stick with me through the details because that is where God or the Devil, whichever metaphor you prefer, resides. Unless more citizens and public officials understand the details, the private interests will defeat the public interest almost every time.
Part of my compact with you is that I will make this book as readable as I can. To that end, I have put the footnotes on the related pages of text so you can see them. I would like to have written without footnotes, but then you might rightly ask, “Where did he get that from?” I also have included an Appendix, written by NYU finance professor Lawrence J. White, that explains the concepts of leverage and capital. Some of this book is technical; but it is written, I hope, so that non-technical readers can understand the technical parts, and
then enjoy their ability to feel informed as they read the rest.
1 New York Times, December 21, 2008.
