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Spain’s credit rating problem could be ours next


9:20 am - May 30th 2010

by Adam Lent    


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The credit rating agency Fitch yesterday cut Spain’s credit rating from AAA to AA.

Have they done this because they think Spain is not getting to grips with its public finances? No.

They’ve cut the rating because the Spanish Government’s efforts to reduce their budget deficit through cuts.

…will materially reduce the rate of growth of the Spanish economy over the medium term.

This is an important development that blows out of the water claims by European governments, including the UK’s, that cuts are the best way to avoid loss of credibility with the markets.

It is a vindication of those who have been pointing out recently that austerity packages will not only damage economic performance but do nothing to calm the markets.

——–
cross-posted from Touchstone blog

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About the author
Adam is an occasional contributor, former Head of Economics TUC, Associate Fellow at IPPR and co-author of 'In The Black Labour'.
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Reader comments


Haha, WIN. Conclusion: ratings agencies aren’t all-avenging free-market gods come to SMITE DOWN WASTE, they’re just, erm, fairly clever people trying to work out how likely countries are to be able to pay back their debt.

Of course, should the government announce a round of privatisations of anything they have left then AAA would magically reappear.

Its all about capitalists coercing governments into handing over national assets.

It is such a fucked up situation though in Spain.

The country was living almost completely off a property boom with no equivalents in the EU, Britain included.

That ground to a halt sharpish bringing down enormous chunks of the economy in the process.

Up to last week Spanish banks had managed to sweep all the crap under the carpet but now the crisis has officially reached them too.

Spain has a 20% unemployment rate (though not to be believed fully- black market and tax evasion in Spain is rife). Between 2009 and now, however, hundreds of thousands construction workers were kept afloat by the government as they pumped money into a huge number of roadworks, infrastructure project and various public works (the infamous “Plan E”).

That’s now gonna end because of the emergency cuts (which make the £6.2bn in the UK look like a joke in comparison). How Spain is gonna wriggle out of it, I really don’t know.

4. gastro george

They’ve cut the rating because the Spanish Government’s efforts to reduce their budget deficit through cuts.

…will materially reduce the rate of growth of the Spanish economy over the medium term.

So let me get this right. A countries rating will be downgraded unless they reduce their budget deficit. And it will be downgraded when they reduce their budget deficit. Tough choice …

@Claude,

All you say is true – you could also have mentioned that like Greece and unlike the UK, Spain has lots of short-term debt. But one of the key arguments of the more thoughtful deficit hawks is that it is important to cut early to pre-empt any herd panic by the market which could irrationally lump the UK in with the weaker EU nations. By that logic though panic generated by growth fears could also leave the UK exposed as an over-zealous cutter. It just shows how carefully governments need to tread and how vital it is EU governments work together to calm very insecure and contradictory markets.

“It just shows how carefully governments need to tread…”

Indeed.

We can’t go off and have more stimulus because the markets won’t lend us the money. We can’t slash the £100 billion off public spending required to close the structural deficit because we’d end up back in recession and thus see debt climb ever higher as a percentage of the economy.

Thus we need growth but we’re boxed in by not being able to get that necessary growth via Keynesian mechanisms.

So, what to do?

Well, why not get that growth through non-Keyensian mechanisms then?

Time to dust off those books on supply side economics methinks (and no, this doesn’t just mean lower marginal tax rates nor just privatisation. It means reform of the supply side of the economy).

Perhaps we might want to move to something closer to the Danish model? You know, a straight classically liberal economy (which it is) with redistribution perched on top?

The OECD report last week just added to the insanity of asking governments to crash their economy today in anticipation of what markets might think in the future. Martin Wolf, ever a sane voice crying out against repeating the mistakes of the past had a good column in the FT, exposing the idiocy of slash and burn.

‘ I have now lost faith in the view that giving the markets what we think they may want in future – even though they show little sign of insisting on it now – should be the ruling idea in policy. So now should the OECD. ‘

The FT is subscription so I have copied the hole article below.

Spare Britain the policy hair shirt

By Martin Wolf

Published: May 28 2010 03:00 | Last updated: May 28 2010 03:00

The UK should tighten fiscal and monetary policy now, in the depths of a slump. That, in essence, is what the Organisation for Economic Co-operation and Development calls for in its latest Economic Outlook. I wonder what John Maynard Keynes would have written in response. It would have been savage, I imagine.

The OECD argues: “A weak fiscal position and the risk of significant increases in bond yields make further fiscal consolidation essential. The fragile state of the economy should be weighed against the need to maintain credibility when deciding the initial pace of consolidation, but a concrete and far-reaching consolidation plan needs to be announced upfront.” Furthermore, monetary tightening should begin no later than the fourth quarter of this year, with rates rising to 3.5 per cent by the end of 2011.

Let us translate this proposal into ordinary language: “If you are unwilling to starve yourself when desperately ill, nobody will believe you would adopt a sensible diet when well.” But might it not make sense to get better first?

Here are some facts, to keep the hysteria in check: the UK economy is operating at least 10 per cent below its pre-crisis trend; the OECD estimates the “output gap” – or excess capacity – at slightly over half of this lost output; the UK government is able to borrow at a real interest rate of below 1 per cent, as shown by yields on index-linked gilts; the yield on conventional 10-year gilts is 3.6 per cent; the ratio of gross debt to gross domestic product was 68 per cent at the end of last year, against 73 per cent in Germany and 77 per cent in France and an average of 87 per cent since 1855; the average maturity of UK debt is 13 years, according to the International Monetary Fund’s Fiscal Monitor; and, yes, core inflation has risen to 3.2 per cent, but that is hardly a surprise, given the large – and essential – sterling depreciation.

Above all, the private sector is forecast by the OECD to run a surplus – an excess of income over spending – of 10 per cent of GDP this year. On a consolidated basis, the UK’s private surplus funds nearly 90 per cent of the fiscal deficit. Thus, fiscal tightening would only work if it coincided with a robust private recovery. Otherwise, it would drive the economy into deeper recession. Yes, that is a Keynesian argument. But this is a Keynesian situation.

I agree that there needs to be a credible path for fiscal consolidation that would lead to a balanced budget, if not a surplus. That will be essential if the UK is to cope with an ageing population in the long term. I agree, too, that the path needs to be spelled out. Given the high ratios of spending to GDP – close to 50 per cent – the best way to proceed is via tight, broad-based, long-term control over expenditure. But a substantially faster pace than envisaged by the last government might threaten recovery: the OECD, for example, forecasts economic growth at 1.3 per cent this year and 2.5 per cent in 2011. Even this would imply next to no reduction in excess capacity.

Of course, one might argue that ultra-loose monetary policy should be used as an offset. But the OECD wants to remove that support, too. Why the OECD makes this recommendation is beyond me.

A good argument might be that monetary policy is a damaging way of refloat the economy, since it tends to weaken the exchange rate (and so raise inflation), increase prices of houses and other assets, and encourage borrowing by a grossly over-indebted private sector. But if one took this line, one should surely argue against rapid fiscal tightening. Thus, while the conventional wisdom is that the best combination is tight fiscal policy and ultra-loose monetary policy, that might be a mistake.

Against the background of rapid fiscal tightening, even ultra-loose monetary policy might prove ineffective. The growth of broad money and credit remains very low, for example. Moreover, sterling’s real effective exchange rate has stabilised since early 2009 and the pound has recently strengthened against the euro. None of this suggests that monetary policy is now too loose. That would be still more true after a big fiscal contraction. If there were a sharp monetary tightening as well, the chances of renewed recession are very high, particularly now that the eurozone seems likely to be more feeble than hoped a few months ago.

The OECD seems to take the view that the only big risk is a loss of fiscal and monetary “credibility”. It is not. The other and – in my view, more serious – risk is that the economy flounders for years. If that happened, eliminating the fiscal deficit would be very hard.

If, as the OECD and Britain’s coalition government believe, fiscal tightening must be accelerated, the corollary is ultra-loose monetary policy, until recovery is established. If, alternatively, monetary policy is ineffective, as it may be, fiscal tightening should be announced, but implementation should be postponed until recovery is secure. I have now lost faith in the view that giving the markets what we think they may want in future – even though they show little sign of insisting on it now – should be the ruling idea in policy. So now should the OECD.

“Well, why not get that growth through non-Keyensian mechanisms then?”

Wands are still in short supply – proactive government policies to promote endogenous growth take years to work through. We are still debating how much the Thatcher governments of the 1980s fostered an improvement in productivity growth. Even so, productivity in Britain’s economy is still not outstanding by international standards and productivity growth is the principal source of improvements in average real living standards:
http://www.statistics.gov.uk/cci/nugget.asp?id=160

In Sunday’s press, the British Chamber of Commerce are warning:

“The worsening eurozone debt crisis and financial market upheavals of recent weeks risk plunging Britain back into recession, the British Chambers of Commerce (BCC) warns today. . . It also wants a credible deficit-cutting plan and a freeze in the total public sector wage bill, but warns that fiscal tightening beyond the £6bn already announced by the chancellor, George Osborne, should be implemented only when the recovery is ‘definitively more secure’.”
http://www.guardian.co.uk/business/2010/may/30/british-chambers-commerce-recession-warning

In the first quarter of this year, business investment was running 11% down on the same period a year ago:
http://www.statistics.gov.uk/cci/nugget.asp?id=258

I read that Martin Wolf article too last night, as it was referenced by Paul Krugman. They’re both annoyed at Osbornomics.

10. gastro george

Time to dust off those books on supply side economics methinks

What restraints do you think there are on private investment right now? As Richard W’s article shows, we have excess capacity. Labour is available. Money is virtually free. Yet private investment is still considerably down. Any thing more we need to do to get these reluctant entrepreneurs moving?

In fact, governments have few policy levers to pull to promote supply-side economics. As always, the challenging issues tend to be in the detail.

Better access to capital markets for small business? Sure, but small businesses have a highish failure rate: only a few survive beyond five years and failing small businesses push up losses for banks.

A more active competition policy to encourage innovation, break up market dominant busineses (like Tesco and Lloyds + HBOS) and force inefficient businesses to close? All those are easier said than done and punished businesses are apt to complain loudly. How do governments encourage innovation except through competition policy?

Recall the house-price bubble?

“American house prices rose 124% between 1997 and 2006, while the Standard & Poor’s 500 index fell by 8%; half of US growth in 2005 was house-related. In the UK, house prices increased by 97% in the same period, while the FTSE 100 fell by 10%.” Robert Skidelsky: Keynes – The Return of the Master (Allen Lane 2009) p.5.

On those figures, investing in second homes and houses to let look a better bet than investing in business equity.

What of this problem, which almost certainly impacts on productivity?

“Up to 12 million working UK adults have the literacy skills expected of a primary school child, the [HoC] Public Accounts Committee says. . . The report says there are up 12 million people holding down jobs with literacy skills and up to 16 million with numeracy skills at the level expected of children leaving primary school.”
http://news.bbc.co.uk/1/hi/education/4642396.stm

Btw the efect of moving benefit recipients into work is very likely to reduce workplace productivity.

12. gastro george

@Bob B

Quite. The engine for growth is SMEs, but our economic system is dominated by finance. The City is far more interested in mergers/acquisitions and creating obscure derivatives – which is only of use to existing large conglomerates. They have no commitment to manufacturing – it’s too long term. As far as they are concerned, SMEs are just something to milk (like retail banking) – easy enough with today’s BoE interest rate.

Now, rebuild RBS as a national investment bank, and force penalties on the other banks if they don’t do the same – that’s the start of a good idea.

[Note to free marketeers about to quote the dead hand of the state – 3i didn’t too badly, did it?]

@12:

Gastro,

I agree with your diagnosis but there is also a very real problem with persistent skill bottle-necks in UK manufacturing because so little has been done to improve opportunities to develop the technical skills needed for jobs in manufacturing. While the routes for teenagers to academic tertiary education are well defined, routes for vocational training opportunities are not.

Try this assessment from the LSE on what happened to productivity growth in Britain during the Blair years:

“Despite the steady improvement in UK productivity over the past decade, there is still a major productivity challenge. First, UK labour productivity is still lower than in France, Germany and the United States. Second, most of the recent GDP growth seems to have been driven by the growth of employment and capital rather than by true efficiency (TFP) improvements.

“Recent evidence suggests that the factors behind the UK productivity gap include deficits in innovation, skills and management practices, as well as regulatory constraints in the retail sector.Tackling these problems together is likely to remain a challenge.”
http://cep.lse.ac.uk/briefings/pa_uk_productivity.pdf

We should remember that these so called credit ratings agencies that we must all bow and scrape too were the same people who were telling us just before the crash that sub prime American mortgages were worth a triple AAA rating.

I would not trust these clowns with a ham sandwich, let alone a nations ratings.

“I would not trust these clowns with a ham sandwich, let alone a nations ratings”

Your scepticism about the performance of rating agencies is well-founded on the strength of ratings prior to the onset of the international financial crisis but the participants of finance markets are apt to take seriously the grades awarded by these agencies.

To see how Britain’s budget balance, current-account balance of payments and, importantly, the yield on 10-year government bonds compare with other affluent countries, check out this table from Saturday’s The Economist:
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=16220574

British government bonds have not been downgraded but the interest yield on British government 10-year bonds is 3.54% compared with 2.64% for German government bonds, or 7.7% for Greece and 4.2% for Spain. The differences in yields partly or mostly reflect differences in market sentiment about the possibilities of default risk in the case of Eurozone government bonds and default with exchange risk in the case of UK government bonds.

@ Adam Lent

Not that anyone in hte market really listens to the ratings agencies, who are reactionary and backward looking, but you shouldn’t really misquote them as badly and deliberately as you have in your article.

Spain wasn’t downgraded because it is cutting spending. Spain was downgraded because it has too high a budget deficit, too much crappy mortgage debt and massive financial problems. Either it can keep spending and suffer the same fate as Greece (which will end in default) or it can cut spending. Medium term growth is going to suffer either way, bt going the way of Greece is by far the worse option. The ratings agencies are just bowing to the reality of the situation.

About ratings agencies, try this recent news report in the FT:

“Credit rating agencies are still being paid millions of dollars a year to report on the performance of collateralised debt obligations that have lost most of their value despite having been issued in many cases with triple A stamps of approval.

“The fees, known as ‘ratings surveillance’ payments, are paid to the agencies ahead of any payments to investors under the terms of the CDO contracts – and without regard to how accurate the original ratings were.”
http://www.ft.com/cms/s/0/606af4d2-52f8-11df-813e-00144feab49a.html

@17 Bob B

Hell, I don’t believe in Father Christmas, the easter bunny or Moody’s, but it doesn’t change the facts;

Ratings agencies are at best backward looking and reactionary. They almost never try and predict what will happen, and are usually quite a way behind the curve. They really only exist because many institutional investors are forced (by law) to offer pension investments with a certain level of security or safety, and there is currently no other way to judge how “safe” an investment is other than through said credit ratings. A poor system, but one governments around the world have forced into existence through legislation.

CDOs are a long story in themsleves. Crappy mortages don’t look so crappy if house prices keep going up and short term borrowing is very cheap. They look even safer if you bundle millions of them together and only expect a certain % of them to go bust. Remember also that subprime and CDOs were created almost overnight by Bill Clinton’s CRA act, forcing banks to lend to otherwise not credit worthy borrowers. Banks had to keep lending (by law), but also had to find a way to get rid of these poor quality loans from their balance sheets. ANother prime case of the rule of unintended consequences.

Oh *please*, I thought that CRA myth was well and truly dead?

The CRA myth is utterly discredited, in the eyes of people who understand what they’re talking about and aren’t idiots. Sadly, our Tyler falls into neither of these camps.

Well, what d’you expect from someone who idolizes a fictional insane mass-murderer…?

CRA myth?

Go take a look at charts of Alt-A and Subprime lending pre and post CRA. If you want to be really finicky, it was around 98-99 that the Clinton administration started forcing FNMA and FHMC to increase the subprime parts of their portfolios vastly, as the CRA wasn’t working as well as they’d hoped.

Truth hurts boys, doesn’t it?

22. Matt Munro

Since when is it a myth ?? It’s well documented in the US and here. Left wing governments wanted everyone to have “the right” to own a home, whether they wanted/could afford to or not. Banks won’t lend what they aren’t going to get back without being forced to, surely that’s obvious, even to the economically challenged.

Tyler, Matt – out of interest, how many deaths is Rachel Carson responsible for?

“It’s well documented in the US and here. Left wing governments wanted everyone to have “the right” to own a home, whether they wanted/could afford to or not. Banks won’t lend what they aren’t going to get back without being forced to, surely that’s obvious, even to the economically challenged.”

You do talk so much clap trap. First off The Clinton govt was hardly left wing. They helped deregulate the financial system. I know anything to the left of Ann Rand is left wing to you people, but really you do make yourself look foolish when you spout this nonsense.

Second, Banks just do as they are told do they? They just roll over and do what the politicians say. I think not. Not that there is any proof that bankers were made to lend recklessly.

Your claim about banks lending only when they will get it back is not backed up by history.

@22: ” Left wing governments wanted everyone to have “the right” to own a home, whether they wanted/could afford to or not.”

These academics claimed (amazingly) that the house-price bubble in Britain was an illusion:
http://www.nuffield.ox.ac.uk/users/murphya/Bubbles.pdf

Not everyone agreed:

Goodhart warns on house price boom
http://www.telegraph.co.uk/finance/economics/2758979/Goodhart-warns-on-house-price-boom.html

From The Economist of 3 April 2008:

“In the latest World Economic Outlook, Roberto Cardarelli of the IMF calculates the share of the increase in real house prices between 1997 and 2007 that cannot be accounted for by fundamental factors such as lower interest rates and rising incomes. This ‘house-price gap’ is greatest for Ireland, the Netherlands and Britain, where prices are about 30% higher than can be justified by fundamentals. France, Australia and Spain have house-price gaps of around 20%. In America, where prices were already falling in 2007, the gap is just over 10%. . . ” (subscription barrier)
http://www.economist.com/finance/displaystory.cfm?story_id=10974135

@24: “Your claim about banks lending only when they will get it back is not backed up by history.”

Try Alan Greenspan, previously chairman of the Board of Governors of the US Federal Reserve Bank:

“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”
http://online.wsj.com/article/SB122476545437862295.html

“out of interest, how many deaths is Rachel Carson responsible for?”

Ooooh, Oooh, I know this one!

Many fewer than her detractors claim but rather more than her defenders are willing to admit.

She did start the diatribe against the use of DDT and on hte basis of very little evidence indeed. It turns out that certain raptors (being at the top of the food chain) do/could have problems as a result of accumulation. But not the general holocaust she thought/predicted that DDT in hte environment might have.

The swtopping of DDT as a gernal spray on agricultural land wasn’t really as a result of her work though: that was the build up of resistance in mosquito populations.

DDT was never banned for appropriate indoor uses.

However, that’s not where the story stops. While there wasn’t a general ban on indoor use there very definitely was a decline in funding for such use. This is partly as a result of resistance but also partly (and only partly) because of the demonisation of DDT use following Carson.

Perhaps Carson shouldn’t be held responsible for what the fools who followed her did. But the whole DDT scare has indeed led to some deaths from malaria.

The correct answer is that she and her ideas can be held responsible for some malaria deaths, nmore than her defenders are willing to agree to. And no where near as many as her detractors claim.

Well said Bob B @ 25/26.

@24 Sally.

I didn’t say anything was left or right wing. I simply stated what happened – you read what you wanted to into what I said. I was more trying to make the point that rating agencies and banks operate within government’s laws, and those laws themselves often have unintended consequences. The CRA act is a good example.

As for the main slant of the orginal article – the ratings downgrade is a straw man, and the author has very selectively quoted from Fitch to back up his own point. The real, underlying problem is that Spain spends too much, and has too high debt. The downgrade is because it is becoming less likely that they repay their debts.

Not that this should be a surprise to anyone….the markets have known this for months – it really is a surpirse to me that anyone really cares what Fitch say.

28

I was replying to 22 Matt Munro.

What’s new?

Try the book by Kenneth Rogoff and Carmen Reinhart: This Time Is Different – 8oo years of financial crises (Princeton UP, 2009)
http://www.economics.harvard.edu/files/faculty/51_This_Time_Is_Different.pdf

It’s worth watching an interview by the FT of Carmen Reinhart on recurring patterns in 800 years of financial crises:
http://video.ft.com/v/82349517001/May-3-800-years-of-financial-crises

The recent international financial crisis was in some respects a replay on a larger and wider scale of the Savings and Loan Assocation debacle of the 1980s and 1990s:

“The US Savings and Loan crisis of the 1980s and 1990s was the failure of several savings and loan associations in the United States. More than 1,000 savings and loan institutions (S&Ls) failed in ‘the largest and costliest venture in public misfeasance, malfeasance and larceny of all time.’ The ultimate cost of the crisis is estimated to have totaled around USD$160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government, which contributed to the large budget deficits of the early 1990s.”
http://en.wikipedia.org/wiki/Savings_and_Loan_crisis

Now I first learned about moral hazards in connection with the S&L Association crisis of the 1980s and 1990s on reading the first edition of Donald E Campbell: Incentives (Cambridge UP, 1995, 2nd edition 2006), which is the sort of academic text I would expect officials in treasuries, central banks, and financial services regulation to read and take note of.

31. Richard W

Tyler, The Community Reinvestment Act was passed in 1977. The subprime bubble started to inflate in err 2002. Only 6 percent of subprime loans were CRA-eligible. Have a look at the chart on page 9 to see when the subprime bubble started to inflate under the err left-wing government of George W Bush and Dick Cheney.

http://subprimer.org/files/wall-street-and-the-making-of-the-subprime-disaster.pdf

Some random facts.

“Our own experience with CRA over more than 30 years and recent analysis of available data, including data on subprime loan performance, runs counter to the charge that CRA was at the root of, or otherwise contributed in any substantive way to, the current mortgage difficulties.” Fed chairman Ben Bernanke

Most subprime mortgages not issued by institutions under CRA. In a paper published on the website of the Federal Reserve Bank of San Francisco, Michigan law professor Michael Barr stated that as of 2005: “Only 25 percent of subprime loans were made by banks and thrifts, and the Federal Reserve reports that only six percent of subprime loans were CRA-eligible.” Similarly, a 2008 study by a law firm specializing in CRA compliance estimated that in the 15 most populous metropolitan areas, 84.3 percent of subprime loans in 2006 were made by financial institutions not governed by the CRA.

Janet Yellen, ( who is a Republican ) president and CEO of the Federal Reserve Bank of San Francisco, in a March 2008 speech criticized efforts to blame CRA lending for weaknesses in the mortgage market, stating:

There has been a tendency to conflate the current problems in the subprime market with CRA-motivated lending, or with lending to low-income families in general. I believe it is very important to make a distinction between the two. Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households. We should not view the current foreclosure trends as justification to abandon the goal of expanding access to credit among low-income households, since access to credit, and the subsequent ability to buy a home, remains one of the most important mechanisms we have to help low-income families build wealth over the long term.

Daniel Gross, a business columnist for Newsweek and author of Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, criticized the notion that affordable housing initiatives caused the financial crisis, writing that “the notion that the Community Reinvestment Act is somehow responsible for poor lending decisions is absurd” and that “lending money to poor people and minorities isn’t inherently risky. There’s plenty of evidence that in fact it’s not that risky at all.” Gross further explained, “On the other hand, lending money recklessly to obscenely rich white guys … can be really risky. In fact, it’s even more risky, since they have a lot more borrowing capacity.”

Timmeh @27 – pipe down, I didn’t ask you.

33. Matt Munro

Sally – CDOs work on the basis that a (hopefully small) percentage of the syndicated debt will go bad/be impaired. When that percentage gets too large the entire asset is hard to value/worthless/high risk. Banks work on percentages, not absolutes. Obviously they are going to occasionally lend and not get it back (even low risk borrowers occasionally go bad) but that must be outweighed by the return they get from the good debt, otherwise the whole business goes under……….

@ “10 What restraints do you think there are on private investment right now? As Richard W’s article shows, we have excess capacity. Labour is available. Money is virtually free. Yet private investment is still considerably down. Any thing more we need to do to get these reluctant entrepreneurs moving?”

Unfortunately excess capacity and free money are economic i.e theoretical constructs – I think you’ll find that the real world experince of many SMEs is that working capital is impossible to get hold of – banks are calling in loans/upping rates or just refusing to lend to SMEs.

@31 Richard W

Chart reading fail. Your chart shows securitizations, not subprime loans themselves. Securitization took off after 1999 repeal of Glass Steagal.

The reviews of CRA in 1995 and 1999 by the Clinton administration lead to the boom in subprime. CRA was replaced ENTIRELY in 1995 by new and updated legislation.

From memory, but I’m sure I can find the official figures with a little digging, at the end of 2007 under 10% of home loans were subprime ARMs. However just OVER 40% of all foreclosures we on subprime loans (and interestingly, about 25% of CDOs were in default because of it, showing that CDOs were actually safer than the underlying loans, though not as safe as advertised).

Not all lenders were under the auspices of the CRA act (so their Alt A and SP loans don’t show up in official FDIC statistics, as abused by Krugman, Yellen et al), but most, if not all ended up offering similar products post 2001 to stay competative within their induatry. Low interest rates meant that normal mortgages were just not as competative when you could have a “2-28” or “5-25” loan and pay little for a few years then simply remortgage.

That last bit is really important. Consumers were actively picking ARM style reset mortgages because they were cheaper, so mortgage lenders moved to offer their customers those products to win business. Those mortgages themselves are geared to let people leverage themselves up highly with low initial rates. Not all subprime loans were made under the CRA, but the whole market moved to reflect that style of mortgage. Why would someone lock in at over 5% for 25 years when they can pay as little as 1% for 2 years, then remortgage?

I personally can remember (around 2002 i think) FNMA boasting about how big their subprime CDO portfolio was getting, and how they were likely to get it to $500bn by 2010.

Sure, banks made some poor lending decisions, and deserve some of the blame. Ratings agencies were also pretty useless. However, they aren’t the only people to blame here. Governments made terrible deicisions as well, were spending too much and were using housing markets as a supercharged wealth and tax generator – they stoked this fire. Lastly, the mortgage buying public also deserve plenty of approbation as well – after all, many people went out and borrowed far more than they could ever afford to pay back. No one is totally innocent here.

I hope that is a fairly unbiased overview of the subprime crisis, but CRA 95 and FSMA 99 both created the motivation and the tools for banks to start subprime lending on a meaningful scale.

35. Richard W

Tyler, the securitization and sub-prime loans are two sides of the same coin. Here is a chart showing the growth in mortgages during the Bush Presidency.

Fig 2 p 59
http://www.oecd.org/dataoecd/33/6/42031344.pdf

A BBC chart showing the growth in sub-prime lending after 2002

Right hand side 2nd down
http://news.bbc.co.uk/1/hi/business/7073131.stm

I think we can both agree that sub-prime lending, teaser rates and lax lending standards were to blame. However, the Republican talking point of blaming the poor to get Wall Street off the hook is what I object to. We know they are the ones who defaulted on their mortgage but the big investment banks were the ones pouring finance to the sub-prime lenders in the first place.

The Clinton administration made some terrible deregulation decisions during the 1990s. However, this was not all down to evil Democrats. The relevant part of Glass-Steagall was repealed by the Gramm-Leach-Bliley Act, it was signed into law by Clinton but it was a Republican bill. Some people blame the repeal for the crisis others do not.
http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act

I agree with you that ‘ no one is totally innocent here ‘.

errrrrrrrr, i think money is printed by the royal mint,errr like in wales man. i think we err own it ( well some rich people do at least,not me personally) err, they are the masters and we’re the slaves folks, just see the reality!!!!! you prostitute yourselves for a pittance while they laugh.


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  1. Liberal Conspiracy

    Spain's credit rating problem could be ours next http://bit.ly/bKnzfL

  2. Robert Wooding

    RT @libcon Spain’s credit rating problem could be ours next http://bit.ly/dnbBQU

  3. Nautilus in Red

    RT @libcon: Spain's credit rating problem could be ours next http://bit.ly/bKnzfL

  4. cara shawn

    Spain's credit rating problem could be ours next | Liberal Conspiracy: The credit rating agency Fitch yesterday cu… http://bit.ly/9yVxFC

  5. ExPatsSpain

    Spain's credit rating problem could be ours next | Liberal Conspiracy http://bit.ly/aA4i0N

  6. Alex Ross

    Spain’s credit rating problem could be ours next http://bit.ly/a7SVco

  7. Political Animal

    RT @Alex_Ross1983 Spain’s credit rating problem could be ours next http://bit.ly/a7SVco

  8. Joe McCrohon

    RT @libcon: Spain's credit rating problem could be ours next http://bit.ly/bKnzfL

  9. Tristan Osborne

    RT @Alex_Ross1983: Spain’s credit rating problem could be ours next http://bit.ly/a7SVco

  10. Naadir Jeewa

    Reading: Spain’s credit rating problem could be ours next: The credit rating agency Fitch yesterday cut Spain’s cr… http://bit.ly/cAVI9X

  11. Stephen Whitehead

    Could cuts harm our credit rating? http://bit.ly/a5HFJ4 (via @libcon)

  12. Rogue

    "Spain’s credit rating problem could be ours next" – http://is.gd/cvJY8 – Spain punished by markets for spending cuts.

  13. Liberal Conspiracy

    Spain's credit rating problem could be ours next http://bit.ly/bKnzfL

  14. Tweets that mention Spain’s credit rating problem could be ours next | Liberal Conspiracy -- Topsy.com

    […] This post was mentioned on Twitter by Liberal Conspiracy, Robert Wooding. Robert Wooding said: RT @libcon Spain’s credit rating problem could be ours next http://bit.ly/dnbBQU […]

  15. scott joy

    Spain's <b>credit</b> rating problem could be ours next | Liberal Conspiracy http://bit.ly/9Oq6gW

  16. Brad Hanshaw

    Spain's credit rating problem could be ours next | Liberal Conspiracy: The credit rating agency Fitch yesterday cu… http://bit.ly/9yVxFC

  17. Susan Rosen

    Spain's credit rating problem could be ours next | Liberal Conspiracy: The credit rating agency Fitch yesterday cu… http://bit.ly/9yVxFC

  18. Fitch: Spanish House Prices To Fall Another 20% « Econotwist's Blog

    […] Spain’s credit rating problem could be ours next (liberalconspiracy.org) […]





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