Notes
NOTES Introduction 1. Even ‘‘rational ignorance’’ and ‘‘asymmetric information,’’ the two main theoretical concessions economists make to ignorance, posit ignorance as a deliberate decision , made by an agent who is either weighing the cost of learning something against its benefit, or an agent whose self-interest is served by hiding information from other agents (Evans and Friedman 2011). Given the lack of conceptual space in contemporary economics for genuine, inadvertent ignorance, economists have little choice but to turn to ‘‘irrationality’’ theories to account for errors. We criticize both sides of this dilemma in Chapter 1. Chapter 1. Bonuses, Irrationality, and Too-Bigness: The Conventional Wisdom About the Financial Crisis and Its Theoretical Implications 1. Fannie Mae was created by the Federal Housing Authority in 1938. In 1968, in an effort to remove Fannie Mae’s costs from the federal budget, Congress passed the Charter Act, reconstituting Fannie Mae as a ‘‘government-sponsored private corporation ’’ regulated by the Department of Housing and Urban Development. In other words, Fannie was ‘‘privatized’’ so that its debt would no longer be on the federal books. The private status of Fannie Mae allowed its profits to accrue to shareholders rather than the U.S. government, but the implicit government guarantee for its debt remained, since this was essential to its purpose ever since it had been created during the Great Depression: to artificially stimulate the private origination of mortgages. The 1968 Act also authorized Fannie Mae to issue mortgage-backed securities, and it created the Government National Mortgage Association, or Ginnie Mae, to guarantee federally originated mortgages to veterans and government employees (this had formerly been one of Fannie Mae’s functions.) In 1970, Congress created the other GSE, Freddie Mac, to compete with Fannie Mae. 2. Specifically, we use the lower curve displayed in Ivashina and Scharfstein (2010, Fig. 2). The authors kindly provided us with the data. 3. Another part of the explanation for the size of the housing bubble, we believe, is the favorable treatment given to both mortgages and mortgage-backed securities by 176 Notes to Pages 15–33 the Basel rules, which we discuss in Chapter 2. However, the size of the housing bubble is relevant only to its negative effect on banks’ lending when the bubble popped, as we explain later on. 4. There were in fact often more than thirteen tranches, even more finely differentiated . 5. Usually the funding advantages enjoyed by the GSEs enabled them to monopolize the market for securitizing prime mortgages, but an exception was the securitization of ‘‘jumbo’’ prime mortgages, which are offered to borrowers with high credit scores who want to buy houses that are too expensive to ‘‘conform’’ to GSE guidelines. 6. For instance, in the second quarter of 2007, nationally chartered banks originated $73 billion worth of home mortgages, while state-chartered banks originated $28 billion worth. (This information was kindly provided by Katherine G. Wyatt of the FDIC.) 7. The figure for U.S. banks given here is one-third lower than in Table 1.1, row 1, column 2, partly because the figure here is based on numbers provided to Greenlaw et al. 2008 by Goldman Sachs a year before the report on which Table 1.1 is based (Lehman Brothers 2008), but mostly because some of the collateral of PLMBS consisted of mortgages that were prime but ‘‘jumbo’’—too large for the GSEs to securitize. We rely primarily on the figures in Table 1.1 because they are more recent and because the prices of mortgage bonds, for mark-to-market purposes, were based primarily on their rating and vintage, not their collateral composition; this was especially true when active markets dried up and ABX indices of ‘‘representative’’ CDS tranches were used instead of actual prices (see Chapter 3). 8. Senator Phil Gramm, the driving force behind Gramm-Leach-Bliley, was a former economics professor, as was Representative Dick Armey, who at the time GLBA was enacted was the House majority leader. Virtually all decision-making personnel at the Federal Reserve, the FDIC, and so on are also university-trained economists. 9. Similar to that of Frank Knight (1921). 10. Because AIG had a triple-A rating, the company was released by many of its counterparties from posting the collateral that was customary with most credit-default swaps. As James Keller (2009) put it, ‘‘In the world of derivatives trading, Lehman, not AIG, was the norm. What this means is that in general, banks have adequate collateral against...
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