This post contains insights not of my own devising, but I haven’t seen enough fuss made about the malign incentives of investment banking and mortgage lending, nor heard a story about what all this creative financing would have done for us if it had worked.
First, the way these worked as Wile E. Coyote headed off the cliff is, you got paid up front when you made the deal. Not when the deal panned out; these are thirty-year deals (for the sleaziest mortgages, at least two- or three-years until evidence of rot could appear, when they reset). So it was all churn; not surprising that thousands of hungry kids, and bosses desperately constrained by the size of their current yachts, would look for ways to make deals around, under, and through those pesky underwriting rules set down by fossils in pince-nez glasses at roll-top desks. Back in the day, lenders had to allocate scarce capital (and post-bust, we see they have entirely forgotten how and just shiver in paralytic tetany); in the boom, they just had to shovel it out, with a nice non-refundable rakeoff from each shovelful.
Of course manufacturing, disciplined by its association with real stuff and physical laws, has long known that piecework compensation is not good for quality; for some reason the workers cut corners and rush carelessly. A good piece of the new regulatory world that’s a-coming would be severe restraints on this kind of pay formula. How it could be enforced by government without causing a lot of mischief is a challenge to policy design. This is more evidence of why it’s not nice to wreck networks of ethical principles and business practices, because social capital is hard to assemble quickly or from the top down. But there it is.
The larger question that’s been troubling me is not being able to tell a story about the benefits of the creativity unleashed in this episode. I am not a luddite about this stuff, and my strong prejudice is for markets. I understand that we are all better off when low-friction capital markets allow goods and welfare to be traded back and forth between the present and the future, and across space. But the bizarre assortment of weird financial instruments that we now can’t figure out how to value seem to have done very little in the line of really increasing welfare, and only redistributed a lot of it to people who were in pretty good shape already, out of retirement funds and savings of people who were just getting by.
The mortgage bonds are claimed to have made a lot of people homeowners, but owning a home is not an unalloyed good for everyone; lots of people are much better off renting, and cities need both rental and owner-occupied housing. The claim is that they gave lots of people bigger houses, but again, what’s special about houses, especially for people who don’t have health insurance or good schools? I thought the market was about not having this or that kind of consumption favored unless there was some kind of market failure afoot.
Can anyone show me that the iPhone would have been two years later, and The Wire never broadcast, if the CDS hadn’t been invented first? The corporation, holder-in-due-course rules, common stock,and other artificial inventions of business ingenuity (not to mention accrual accounting, the one the people who set up the incentive system discussed above obviously never quite understood) – maybe even options – are real productive innovations, responsible for a cornucopia of more stuff over a couple of centuries. Is there anything beyond transfers yielding more houses for people who can only be in one at a time, and more $5000 watches for people with only one left wrist, that we should attribute to the house of cards that just fell in a heap?