Daily Archives: October 3, 2007

How to correct what went wrong in subprime

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subprime%20house.jpgClear Thinkers favorite James Hamilton provides this interesting post on Princeton professor Alan Blinder’s NY Times Sunday op-ed in which Blinder makes the common sense observation that we first have to figure out what went wrong in the subprime mortgage mess before we can “even begin to devise policy changes that might protect us from a repeat performance.”
Blinder proceeds to identify six groups who might bear at least some of the responsibility for the financial fallout: (1) homebuyers who took on mortgages they couldn’t repay; (2) mortgage originators, for issuing mortgages that homebuyers couldn’t pay; (3) bank regulators, who may have dropped the ball in failing to slow down the runaway train; (4) the investors who ultimately provided the funds for the mortgages, and (5) securitization, which led to assets that are too complex for anyone truly to understand, and (6) ratings agencies that underestimated the risk.
Professor Hamilton focuses on group 4, the investors, and makes the following observation:

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.

I agree with Professor Hamilton, although I would point out that the best “fix” of the problem is to allow the market to adjust — with a minimum of regulatory interference — to what happened in the subprime meltdown. Which reminds me of a great line that Arnold Kling passed along the other day while lauding the George Mason economics department:

“I like to put it his way: at [the University of] Chicago, they say “Markets work well. Let’s use markets.” At MIT, they say “Markets fail. Let’s use government.” At GMU, they say “Markets fail. Let’s use markets.”

“We eat what we kill”

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dollar%20roll.jpgBig-time college football is big business. Maybe not as big business as the NFL, but definitely big enough that major universities really ought to dump the obsolescent and hypocritical NCAA regulatory system and form a for-profit system that would pay players market-based compensation similar to minor league baseball.
That such reform makes sense is underscored by the first part of a two part Austin-American Statesman series on the University of Texas athletic department’s finances. Not only has the $100 million UT athletic department budget doubled in the past six years, athletics expenses at UT have grown twice as fast as the universityís overall spending during the same time frame.
Moreover, because of the NCAA’s regulation of player compensation, UT (as with other big-time programs) funnels compensation to players in the form of “resort privileges.” For example, just since UT’s football team won the national title in 2005, the football program has spent more than $200,000 renovating its playersí lounge and $155,000 purchasing a hydrotherapy room to help soothe its playersí sore limbs. That hydrotherapy room probably came in handy for Texas QB Colt McCoy after the licking he took during the Longhorns 41-21 loss to Kansas State last Saturday.
Likewise, the amount of money the university spends per athletehas almost doubled over the past four years, from $113,000 in 2003 to $210,000 this year. Thatís 10 times the average of all Division I and II colleges, and eight times what UT spends educating each of its non-athlete students. When questioned about that discrepancy, the UT athletic department’s CFO replied that the difference is largely meaningless because of the self-supporting nature of the UT athletic program. ìWe eat what we kill,î the CFO told the Statesman.
Which reminds me of the thought that I had when I saw the now popular video of Oklahoma State head coach Mike Gundy going batshit at a newspaper reporter over an article that she had written that was critical of one of his players. Gundy wasn’t wrong in going haywire. He simply went wacko at the wrong target. The target should have the feckless university leaders who perpetuate the facade of intercollegiate football at the expense of the players. It’s high time that the universities engaging in big-time college football start treating it for what it really is — a big business that should pay market compensation to the professional athletes who are responsible for generating most of the income for the enterprise.

Hersh on the plan for Iran

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iran_flag.pngIn this New Yorker article, Seymour Hersh lays out his theory on the Bush Administration’s plans for neutralizing Iran. As with most of Hersh’s work, it is a fascinating read. He concludes with the following story about tensions between Allied forces:

Another recent incident, in Afghanistan, reflects the tension over intelligence. In July, the London Telegraph reported that what appeared to be an SA-7 shoulder-launched missile was fired at an American C-130 Hercules aircraft. The missile missed its mark. Months earlier, British commandos had intercepted a few truckloads of weapons, including one containing a working SA-7 missile, coming across the Iranian border. But there was no way of determining whether the missile fired at the C-130 had come from Iranóespecially since SA-7s are available through black-market arms dealers.
Vincent Cannistraro, a retired C.I.A. officer who has worked closely with his counterparts in Britain, added to the story: ìThe Brits told me that they were afraid at first to tell us about the incidentóin fear that Cheney would use it as a reason to attack Iran.î The intelligence subsequently was forwarded, he said.
The retired four-star general confirmed that British intelligence ìwas worriedî about passing the information along. ìThe Brits donít trust the Iranians,î the retired general said, ìbut they also donít trust Bush and Cheney.î