RTE's Freefall (13/09/10)

Finally got around to watching this program, and to no surprise it was the same old tripe. But what baffled me the most is the conclusions they came to, i.e. that the crisis was a failure of the free market economy, when nothing could be further from the truth. Numerous interviewees stated this, including Bertie. But the one person, being an economist, that made the most contradictory comment was Joseph Stiglitz. His metaphor was down the line that central banks should be in charge of taking away the punch when the party got too heated, but that free markets kept topping up the punch. Either this guy is stupid, deceiving or a fraud. The one institution that can add punch to the bowl, is the central bank, as they are the ones that increased the money supply and kept interest rates low. The free market can only pyramid money on what is provided by central banks.

As for the rest of the program, I found that it focused on all the incentives given to builders and bankers, and that this fueled the property bubble. Now unless the other part of the program, which I missed, focused on the incentives to buyers, then I believe that the most fundamental reason for the inflation of the property bubble was missed. This being government intervention through reduction in stamp duty for first time buyers, followed by no stamp duty for buyers of new developments, followed by no stamp duty for first time buyers at all, followed by affordable housing schemes and joint ownership schemes, followed by ever increasing mortgage interest relief. It was these very actions by government that added ever more buyers and therefore demand to the property market.

The program did go on to to highlight and critisise the incentives given to the construction industry, investors/speculators and banks, through various tax schemes. It also briefly mentioned the facts that banks were bailed out in the 80s and 90s. But how then do they come to the conclusion that the free market failed. A free market, by definition, is a market that is not interfered with by government interventions. Yet the program accentuates some of the interventions of government over the years.

Governments and their central banks provided the money and incentive, through low interest rates, for banks to borrow ever more amounts of money and make ever more loans. As there are only so many prime borrowers available to lend money to, it is no surprise that less attractive borrowers found credit. Then government added incentives to buyers and builders, further increasing artificial supply and demand.

The conclusion should be that government intervention to constantly tweak and twiddle the economy has failed and not the free market..

Now unless the other part of the program, which I missed, focused on the incentives to buyers, then I believe that the most fundamental reason for the inflation of the property bubble was missed. This being government intervention through reduction in stamp duty for first time buyers, followed by no stamp duty for buyers of new developments, followed by no stamp duty for first time buyers at all, followed by affordable housing schemes and joint ownership schemes, followed by ever increasing mortgage interest relief. It was these very actions by government that added ever more buyers and therefore demand to the property market.

Click to expand...

Er, hang on. Not applying taxes equals "government intervention"?

Chris said:

The conclusion should be that government intervention to constantly tweak and twiddle the economy has failed and not the free market..

Click to expand...

Agreed. We never had a capitalist system here in Ireland. If we did, the banks would be bust now, and developers too. Instead we had a half assed system, constantly manipulated by government and government departments. Though in fairness, no country has a true capitalist system, just as no country has a true socialist system. We have a sort of mafia system here, with government, banks and developers running a sort of casino country.

This is not a serious programme.

sunrock said:

This is not a serious programme.

Click to expand...

There were about 20 shots of the dart from different angles, ridiculous...

Plus it really bugs me the way Jim Power thinks he's apologised and can move on with his life. Him and his ilk (economists who didn't understand how to read a balance sheet) were reponsible for this whole mess by purporting to be giving sound advice to Ministers & CEOs. If ever running with the foxes and hunting with the hounds were apt it would be in the case of this imbecile.

It was, like all the David McWilliams docs, a case of style over substance (not saying he made this one btw).

Docs now have to be all about flashy graphics, out of focus and panning camera shots, reiterating same thing 10 times etc. All gloss.

Could have said what they did in 20mins instead of 2hrs.

Plus, hated the way Lenihan chatted about the crisis as if it was ancient history !!

I didn't see the second one, but I hated the bit in the first one where Lenihan was chuckling about missing a call from the head of the ECB for 24 hours because he was at an FF fundraiser race meeting at Kilkenny.

Bizarro

What we have witnessed is a failure of our banking system but that does not mean that system is wrong. Banking as financial intermediation performs an almost alchemic transformation. Its creditors think and expect that they can get their money back on demand or at least at the short time frame that they have lent and they think that there is no risk. The assets on the other hand are long term and risky. That is almost magic and tremenduously useful for society. Imagine if people taking out a 20 year mortgage relied on being matched with someone who could wait 20 years for their money and could accept the risk that the mortgagee mightn't be able to pay back.

Our banking system provides almost incredible maturity and risk transformation for society. But clearly this can go wrong and it did. Who's to blame? Certainly not the concept itself which properly controlled is hugely beneficial for society. The bankers? Yes. The Regulators? Yes. The government? Yes. Human nature? Absolutely yes.

The programme did not mention anything about the government's decisions regards stamp duty. This certainly was a factor in house prices increasing.
I know people that bought one-bed aprtments for 317K just because that was the limit at which they did not have to pay stamp duty. They found that all apartments they were bidding on that were priced at 280-290K ended up going to 317K.
Also at the peak, all starter homes in my area were getting 381K just because stamp duty was 3% under this amount and 6% over it.

I read an article a few months back were they list 5 decisions Brian Cowen took as MOF, which fueled the bubble. Increasing the stamp duty limits was one of them and the author stated that in one year this measure alone contributed to a 10% increase in house prices.
I cannot find link for it.

Interesting points shawady but the fact remains that Irish stamp duty was very high relative to other countries. The boom in property prices happened despite our high stamp duty not because of it.

canicemcavoy said:

Er, hang on. Not applying taxes equals "government intervention"?

Click to expand...

Yes. For example, cigarettes would be a hell of a lot cheaper if the government decided not to tax them at all. Petrol and Diesel too. When the government removes tax from something, it can be assumed that they are encouraging it, or the consumption of whatever it happens to be.

Duke of Marmalade said:

Interesting points shawady but the fact remains that Irish stamp duty was very high relative to other countries. The boom in property prices happened despite our high stamp duty not because of it.

Click to expand...

The couple I mentioned in above example example also got 100% mortgage and borrowed probably 5/6 times their salary so certainly other factors at play. However, when they increased stamp duty limits, these became price ceilings at which people were prepared to go to.
I remember when we moved house about 4 years ago an estate agent told he had just valued a house for 340K but it sold at 381K. He was genuinely shocked at how people were bidding for houses.

Chris said:

The free market can only pyramid money on what is provided by central banks.

Click to expand...

I know you see the root of the whole problem as loose control of the money supply. But in fact this global crisis started from a credit explosion that bypassed the monetary mechanisms. The securitisation of mortgages involves the creation of credit without increasing money supply. Securitisation purports to enable a massive risk/maturity transformation. The assets were long term and risky, increasingly so (sub prime). The liabilities i.e. the suppliers of the funds believed that they had relatively liquid securities. They also believed that the risks were low. Clever dudes sliced and diced the packaging so that some of the securities got AAA rating and others got less but in total a delusion developed that in aggregate the securities were less risky than the assets backing them.

This was totally a failure of free market capitalism and human greed, wishful thinking and hubris. The PhDs in the rating agencies thought they were oh so clever. The mortgage brokers and banks were greedy. The sub prime borrowers wondered why they were being lent to but wanted to believe that it must be okay. Pension funds in Europe were taken in by the whole confidence trick.

A Gold Standard or other tight monetary discipline would not have prevented this massive self delusion, it would in fact have encouraged it by making people all the more keen to disintermediate away from the controlled monetary system.

shnaek said:

Yes. For example, cigarettes would be a hell of a lot cheaper if the government decided not to tax them at all. Petrol and Diesel too. When the government removes tax from something, it can be assumed that they are encouraging it, or the consumption of whatever it happens to be.

Click to expand...

So when government apply tax to something, they are intervening, and when they don't apply tax, they are intervening.

Sorry, I'm trying to get my head around that one.

Plus it really bugs me the way Jim Power thinks he's apologised and can move on with his life.

Click to expand...

It's a fair point but at least he has apologised. Many who did the same thing are carrying on blithely, and some even still won't admit there actually was a property bubble.

canicemcavoy said:

So when government apply tax to something, they are intervening, and when they don't apply tax, they are intervening.

Sorry, I'm trying to get my head around that one.

Click to expand...

When the government cuts or increases taxes or subsidies, with the explicitly stated intention of encouraging certain behaviour within a particular market, of course this constitutes intervention in the market. In my opinion, its difficult to argue otherwise.

Duke of Marmalade said:

What we have witnessed is a failure of our banking system but that does not mean that system is wrong. Banking as financial intermediation performs an almost alchemic transformation. Its creditors think and expect that they can get their money back on demand or at least at the short time frame that they have lent and they think that there is no risk. The assets on the other hand are long term and risky. That is almost magic and tremenduously useful for society. Imagine if people taking out a 20 year mortgage relied on being matched with someone who could wait 20 years for their money and could accept the risk that the mortgagee mightn't be able to pay back.

Our banking system provides almost incredible maturity and risk transformation for society. But clearly this can go wrong and it did. Who's to blame? Certainly not the concept itself which properly controlled is hugely beneficial for society. The bankers? Yes. The Regulators? Yes. The government? Yes. Human nature? Absolutely yes.

Click to expand...

We have discussed this on many threads, but I still don't see a problem with matching long term borrowing with short term lending in a non-fractional reserve system. Debentures are a perfect instrument for any-term savings and act like bonds. A bank could sell 20 year debentures and lend for 20 years on a mortgage. The owner of the 20 year debenture would not be tied into waiting for 20 years; just like bonds debentures would be actively traded.
The "benefits" of our banking system are also its most vulnerable point, and when a system can so spectacularly fail with such perfect regularity then it is clearly an inappropriate, nonfunctioning system. The only real good comment on the Freefall program was by an English economist or journalist or somethingorother, who said that the global financial system is now so large and so covertly interlaced that it is impossible to regulate. Even the task of gathering, analysing and translating monetary market data is such an impossible undertaking, that central bankers, no matter how intelligent or how many of them, cannot adequately perform, let alone protect the public from corruption or tweaking of data to suit most powerful lobbyists.
And after every crisis they come out with the same old crap (like Ireland's own central bank), that the system of analysing and predicting the economy is going to be modified so that such a disaster will not happen again. But guess what, it always does and always will. There just is no substitute for the free market.

Duke of Marmalade said:

I know you see the root of the whole problem as loose control of the money supply. But in fact this global crisis started from a credit explosion that bypassed the monetary mechanisms. The securitisation of mortgages involves the creation of credit without increasing money supply. Securitisation purports to enable a massive risk/maturity transformation. The assets were long term and risky, increasingly so (sub prime). The liabilities i.e. the suppliers of the funds believed that they had relatively liquid securities. They also believed that the risks were low. Clever dudes sliced and diced the packaging so that some of the securities got AAA rating and others got less but in total a delusion developed that in aggregate the securities were less risky than the assets backing them.

This was totally a failure of free market capitalism and human greed, wishful thinking and hubris. The PhDs in the rating agencies thought they were oh so clever. The mortgage brokers and banks were greedy. The sub prime borrowers wondered why they were being lent to but wanted to believe that it must be okay. Pension funds in Europe were taken in by the whole confidence trick.

A Gold Standard or other tight monetary discipline would not have prevented this massive self delusion, it would in fact have encouraged it by making people all the more keen to disintermediate away from the controlled monetary system.

Click to expand...

I agree that mortgage securitisation played a huge role, not so much here but in the US, which was also set up and encouraged through the US government's Fannie and Freddie.
It is however false to say that the money supply was not at the root of the evil. If the money supply had not been increasing then less money would have been available to buy up mortgage backed securities.
Banks did exactly what governments wanted them to do. In the US Clinton and Bush went public in saying that they would do everything they could to allow more poor people to own their own home. So they increased the money supply, reduced interest rates, reduced the rules on Fannie and Freddie. Then banks went off on lending sprees. This is not failure of the free market, this is total failure of government intervention. At no stage during the boom or the bust has the free market been allowed to work by keeping a balance and punishing mistakes.
People trying to "disintermediate away from the controlled monetary system", i.e. a central bank gold standard, would certainly be possible, but parallel unbacked monetary systems would only work with some sort of government guarantees, or else it would quickly fail. I'm not only opposed to fiat money and fractional reserve banking, but also opposed to central government monopoly of money, and making central bank money legal tender. In a free banking and monetary system, where government is forbidden to interfere, people would be free to use fiat currency or hard currency; paper, sea shells or precious metals. But I would be happy to start with a central bank gold standard.

canicemcavoy said:

So when government apply tax to something, they are intervening, and when they don't apply tax, they are intervening.

Sorry, I'm trying to get my head around that one.

Click to expand...

Any change in government policy, like taxation, that is done with the precise intention of stimulating a certain product, service or industry is an intervention. And the reason stamp duty was constantly modified was to allow/encourage more people to be able to afford to buy a house, which resulted in increased demand and therefore higher prices. This wasn't the only factor, but I believe a major contributing one.
If every tax in the country were reduced by the same percentage, then there would not be a favoured increase in one certain area. This would provide favourable conditions for the entire economy, without stimulation or preferential treatment of one area based on government cronyism.

Chris said:

We have discussed this on many threads, but I still don't see a problem with matching long term borrowing with short term lending in a non-fractional reserve system. Debentures are a perfect instrument for any-term savings and act like bonds. A bank could sell 20 year debentures and lend for 20 years on a mortgage. The owner of the 20 year debenture would not be tied into waiting for 20 years; just like bonds debentures would be actively traded.

If the money supply had not been increasing then less money would have been available to buy up mortgage backed securities.

Click to expand...

You are contradicting yourself here. Mortgage securitisation is precisely what you are advocating - the backing of long term assets by debentures. It is completely neutral on the money supply. This crisis has arisen for precisely the opposite reasons you give. The authorities had indeed got quite on top of control of the money supply as witnessed by very tame inflation in the last couple of decades. What they failed to control was this non monetary credit explosion.

Duke of Marmalade said:

You are contradicting yourself here. Mortgage securitisation is precisely what you are advocating - the backing of long term assets by debentures. It is completely neutral on the money supply. This crisis has arisen for precisely the opposite reasons you give. The authorities had indeed got quite on top of control of the money supply as witnessed by very tame inflation in the last couple of decades. What they failed to control was this non monetary credit explosion.

Click to expand...

No, I think you are misunderstanding my point, or I may not have made it that clear. My example on how to match long term debt with long term savings was merely to show how this would still allow for the advantage you see in matching short term savings with long term debt. The danger with lending long and borrowing short are very evident now, and in my opinion are one of the core failures of the monetary and financial system.
Mortgage backed securitisation was precisely a chopping up of mortgage in order to sell them on easier. While I used a mortgage in my example of the debenture, this would not be restricted, and is not securitisation of mortgages per se, but a more secure form of matching loans with borrowings.
I'm not sure I fully understand your point of the credit explosion, but banks can only build credit on money supplied by central banks. The explosion in credit happened because in some cases the reserve requirements were lowered, while at the same time the money supply was very steadily increased. This is precisely part of monetary expansion of fractional reserve banking and not a failure of the free market!
By inflation I assume you mean the government provided figures in consumer prices. The rise of prices in general is the consequence of the inflation of the monetary supply. And while consumer prices may have stayed "relatively" stable, this is only because the very thing that did inflate in price beyond all reason is real estate. If you were to include real estate in a price index you would see a much clearer correlation between the inflation of the money supply and overall prices in the economy.

Chris said:

I'm not sure I fully understand your point of the credit explosion, but banks can only build credit on money supplied by central banks.

Click to expand...

Bank lends 10 nuggets of gold to A. A buys house from B for 10 nuggets of gold. Bank securitises A's mortgage and sells it to B for 10 nuggets of gold. And so on and so on, infinite credit expansion on the same money supply.

And while consumer prices may have stayed "relatively" stable, this is only because the very thing that did inflate in price beyond all reason is real estate. If you were to include real estate in a price index you would see a much clearer correlation between the inflation of the money supply and overall prices in the economy.

Click to expand...

I agree with the thrust of this comment but asset price inflation had little to do with money supply expansion, rather it was to do with long term credit expansion, as described above. In simplistic terms people do not buy houses with the coins in their pocket they buy then with long term credit.

The slicing and dicing of asset backed securitistion backed by fancy PhD math was the root cause of the global financial crisis. It was a failure of the free market, of human nature, not of government intervention and certainly not of fractional reserve banking.