Greenspan (U.S.) v. Anti-Greenspan (India)
A few days ago, the New York Times published an article "White House Philosophy Stoked Mortgage Bonfire". In some ways, it is a somewhat weak article, but it is worth a read because it does try to get to the heart of the U.S. housing bust - the brainless, ideological, "free market" and "deregulation" fetish of the Bushies that was going to inevitably lead us to this disaster. In many ways, the sentence I have bolded below says everything about how we got here than anything else:
Then his Treasury secretary, Henry M. Paulson Jr., told him that to stave off disaster, he would have to sign off on the biggest government bailout in history.
Mr. Bush, according to several people in the room, paused for a single, stunned moment to take it all in.
“How,” he wondered aloud, “did we get here?”
Paul Krugman comments on the article and notes, among other things:
2. I’m also with Barry Ritholtz that Bush’s emphasis on homeownership was not the problem. Bush favored homeownership; I’m sure he also favored marital fidelity; his influence on homeownership and his influence on adultery were probably comparable. It’s Bush’s opposition to financial regulation that did the evil deed.
Update: The White House has issued a somewhat hysterical response. The main thrust of this response seems to be that Bush gave a speech after the crisis hit explaining the whole thing, and that this proves that he must have known what was going on all along. Oh, kay.
The White House response is predictable and Calculated Risk has a sharp response as well. He points out (emphasis mine through the rest of this post):
The "most significant factor" was "cheap money flowing into the U.S."? Uh, no.
The most significant causes of the credit crisis were innovation in mortgage securitization coupled with almost no regulatory oversight (because of ideologues who opposed oversight and regulation). This led to lax lending standards (liar loans, DAPs, widespread use of Option ARMs as affordability products, etc.) and excessive speculation.
Let us compare what happened in the U.S. to what happened in India, where some of the worst problems in the U.S. mortgage market have so far been avoided despite India's trend towards free markets and deregulation in the last decade and despite the glut of money that was flowing into India during that period. The New York Times published a piece by Joe Nocera a few days ago on this very topic - "How India Avoided a Crisis". It is enormously instructive to read this article to see how India's Mr. Anti-Greenspan had the basic common sense - in comparison to the ideological blinders that Greenspan and Bush had - to foresee the most likely end result of excessive deregulation. Some excerpts:
Note that the Reserve Bank of India is the equivalent of the Federal Reserve Bank in the U.S.
“In India, we never had anything close to the subprime loan,” said Chandra Kochhar, the chief financial officer of India’s largest private bank, Icici. (A few days after I spoke to her, Ms. Kochhar was named the bank’s new chief executive, in a move that had long been anticipated.) “All lending to individuals is based on their income. That is a big difference between your banking system and ours.” She continued: “Indian banks are not levered like American banks. Capital ratios are 12 and 13 percent, instead of 7 or 8 percent. All those exotic structures like C.D.O. and securitizations are a very tiny part of our banking system. So a lot of the temptations didn’t exist.”
And when I went to see Deepak Parekh, the chief executive of HDFC, which was founded in 1977 as the country’s first specialized mortgage bank, practically the first words out of his mouth were these: “We don’t do interest-only or subprime loans. When the bubble was going on, we did not change any of our policies. We did not change any of our systems. We did not change our thought process. We never gave more money to a borrower because the value of the house had gone up. Citibank has a few home equity loans, but most banks in India don’t make those kinds of loans. Our nonperforming loans are less than 1 percent.”
Yet two years ago, the Indian real estate market — commercial and residential alike — was every bit as frothy as the American market. High-rises were being slapped up on spec. Housing developments were sprouting up everywhere. And there was plenty of money flowing into India, mainly from private equity and hedge funds, to fuel the commercial real estate bubble in particular. Goldman Sachs, Carlyle, Blackstone, Citibank — they were all here, throwing money at developers. So why did the Indian banks stay on the sidelines and avoid most of the pain that has been suffered by the big American banks?
Part of the reason is cultural. Indians are simply not as comfortable with credit as Americans. “A lot of Indians, when you push them, will say that if you spend more than you earn you will get in trouble,” an Indian consultant told me. “Americans spent more than they earned.”
But there was also another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan. His name was Dr. V. Y. Reddy, and he was the governor of the Reserve Bank of India.
Seventy percent of the banking system in India is nationalized, so a strong regulator is critical, since any banking scandal amounts to a national political scandal as well. And in the irascible Mr. Reddy, who took office in 2003 and stepped down this past September, it had exactly the right man in the right job at the right time.
“He basically believed that if bankers were given the opportunity to sin, they would sin,” said one banker who asked not to be named because, well, there’s not much percentage in getting on the wrong side of the Reserve Bank of India. For all the bankers’ talk about their higher lending standards, the truth is that Mr. Reddy made them even more stringent during the bubble.
Unlike Alan Greenspan, who didn’t believe it was his job to even point out bubbles, much less try to deflate them, Mr. Reddy saw his job as making sure Indian banks did not get too caught up in the bubble mentality. About two years ago, he started sensing that real estate, in particular, had entered bubble territory. One of the first moves he made was to ban the use of bank loans for the purchase of raw land, which was skyrocketing. Only when the developer was about to commence building could the bank get involved — and then only to make construction loans. (Guess who wound up financing the land purchases? United States private equity and hedge funds, of course!)
Compare that to the U.S. where housing speculation was rampant and large percentages of home purchases were speculative buys by investors to cash in on projected home price appreciation, often funded using "interest-only" loans.
Then, as securitizations and derivatives gained increasing prominence in the world’s financial system, the Reserve Bank of India sharply curtailed their use in the country. When Mr. Reddy saw American banks setting up off-balance-sheet vehicles to hide debt, he essentially banned them in India. As a result, banks in India wound up holding onto the loans they made to customers. On the one hand, this meant they made fewer loans than their American counterparts because they couldn’t sell off the loans to Wall Street in securitizations. On the other hand, it meant they still had the incentive — as American banks did not — to see those loans paid back.
Seeing inflation on the horizon, Mr. Reddy pushed interest rates up to more than 20 percent, which of course dampened the housing frenzy. He increased risk weightings on commercial buildings and shopping mall construction, doubling the amount of capital banks were required to hold in reserve in case things went awry. He made banks put aside extra capital for every loan they made. In effect, Mr. Reddy was creating liquidity even before there was a global liquidity crisis.
In the U.S., in contrast, the expected massive bust in the Commercial Real Estate (CRE) market has only just begun. As Calculated Risk has been pointing out:
- The U.S. head of the Office of Thrift Supervision (OTS) literally took the chainsaw to regulation back in 2003 (see picture and the news about one top OTS official now under investigation/suspension)
- CRE loan defaults are expected to triple over the next year
- The Architecture Billings Index (a 9-12 month leading indicator of new commercial construction) at aan all-time low
- CRE investors are now asking Washington for a bailout.
Back to India:
Did India’s bankers stand up to applaud Mr. Reddy as he was making these moves? Of course not. They were naturally furious, just as American bankers would have been if Mr. Greenspan had been more active. Their regulator was holding them back, constraining their growth! Mr. Parekh told me that while he had been saying for some time that Indian real estate was in bubble territory, he was still unhappy with the rules imposed by Mr. Reddy. “We were critical of the central bank,” he said. “We thought these were harsh measures.”
Ms. Kochhar said that the underlying risks of having “a majority of loans not owned by the people who originated them” was not apparent during the bubble. Now that those risks have been made painfully clear, every banker in India realizes that Mr. Reddy did the right thing by limiting securitizations. “At times like this, you tend to appreciate what he did more than we did at the time,” said Mr. Kapoor. “He saved us,” added Mr. Parekh.
As the credit crisis has spread these past months, no Indian bank has come close to failing the way so many United States and European financial institutions have. None have required the kind of emergency injections of capital that Western banks have needed. None have had the huge write-downs that were par for the course in the West. As the bubble has burst, which lenders have taken the hit? Why, the private equity and hedge fund lenders who had been so eager to finance land development.
Certainly, as the global recession takes hold, India may yet face major problems that might hit its banks, but those are more likely to be related to India's first business cycle downturn in a long time than to an excessive reliance on deregulation and free markets.