"The housing bubble underlies everything, but the financial rocket science really did kick everything into another gear," says Kevin Drum. And he's right. My point from yesterday, however, is that the byzantine nature of the specific instruments has been deployed to bring a sort of passive voice to the crisis. We're getting lot of "perfect storm" language, as if this were an act of God. But it wasn't. It was more like a variant on New Orleans: We knew there would eventually be a storm, and we'd systematically taken down all the levees. The ratings agencies were corrupted, and everyone knew it, and everyone profited from it. The firms were absurdly over-leveraged. Subprime loans became a hot investment ticket. New instruments were developed so companies could take on more, more, more risk.The instruments are part of the story of what happened, but it's not obvious that they were a major part of what allowed this to happen, or what we should change so that it doesn't happen next time. They're too subtle for regulation.New variants could be invented to go around the wording of specific laws. What enabled the crisis, and enlarged the danger, was leveraging. If you had to keep one dollar on hand for every five dollars you had in debt, then it didn't much matter how much risk you assumed. The damage could only be so great. But there were few such regulations (and those who did have leveraging requirements -- namely, the commercial banks -- generally weathered the storm better), and so the appetite for risk could be leveraged into tremendous liabilities. Yesterday, a commenter wrote, "OF COURSE the subprime loans were key--but that's kind of like saying that the bullet was the key to the murder." That says more than he means it to say: When you have a lot of bullets lying around the house, it increases the odds that someone could get shot. When you have a lot of subprime loans bought during a clearly unsustainable housing bubble, it increases the odds that your portfolio is going to blow up. So I still don't understand why Rubin and others are saying nothing could have been done differently. But the question is how they managed to point the gun at the whole economy's head. It's not obvious that we should or could bottle financial innovation. It's too complex. But it does seem clear that we should, and could, cap the level of damage that that innovation can do to the broader economy. And that looks like a matter of regulating leverage more than examining specific instruments. FINANCIAL GUN CONTROL.
"The housing bubble underlies everything, but the financial rocket science really did kick everything into another gear," says Kevin Drum. And he's right. My point from yesterday, however, is that the byzantine nature of the specific instruments has been deployed to bring a sort of passive voice to the crisis. We're getting lot of "perfect storm" language, as if this were an act of God. But it wasn't. It was more like a variant on New Orleans: We knew there would eventually be a storm, and we'd systematically taken down all the levees. The ratings agencies were corrupted, and everyone knew it, and everyone profited from it. The firms were absurdly over-leveraged. Subprime loans became a hot investment ticket. New instruments were developed so companies could take on more, more, more risk.The instruments are part of the story of what happened, but it's not obvious that they were a major part of what allowed this to happen, or what we should change so that it doesn't happen next time. They're too subtle for regulation.New variants could be invented to go around the wording of specific laws. What enabled the crisis, and enlarged the danger, was leveraging. If you had to keep one dollar on hand for every five dollars you had in debt, then it didn't much matter how much risk you assumed. The damage could only be so great. But there were few such regulations (and those who did have leveraging requirements -- namely, the commercial banks -- generally weathered the storm better), and so the appetite for risk could be leveraged into tremendous liabilities. Yesterday, a commenter wrote, "OF COURSE the subprime loans were key--but that's kind of like saying that the bullet was the key to the murder." That says more than he means it to say: When you have a lot of bullets lying around the house, it increases the odds that someone could get shot. When you have a lot of subprime loans bought during a clearly unsustainable housing bubble, it increases the odds that your portfolio is going to blow up. So I still don't understand why Rubin and others are saying nothing could have been done differently. But the question is how they managed to point the gun at the whole economy's head. It's not obvious that we should or could bottle financial innovation. It's too complex. But it does seem clear that we should, and could, cap the level of damage that that innovation can do to the broader economy. And that looks like a matter of regulating leverage more than examining specific instruments. 
